Takeaway: Revenue engine revving hotter than people expect, and it will last far longer as well. But whether GM% could approach 50% is key = $8 EPS.
Every once in a while Nike comes along and reminds the Street of one thing…that once its revenue engine gets turned on, it revs hotter than most people think possible, and sustains that heat far beyond a time frame that most people in the investment community would consider reasonable – or even possible. This quarter was definitely one of those events. We were expecting a blowout – with an estimate of $0.97 vs the Street at $0.88. But Nike beat even our estimate and came in at $1.04 (GAAP was $1.09 including a tax benefit). Futures looked outstanding at 11%, with a 400bp sequential turn higher in North America to +15%, at a time when it should probably have otherwise have dipped into the single digits. We’re taking up our estimate to $3.83 for the year – above Nike’s guidance (and presumably the consensus) of $3.58. At the current multiple of 21x our ’15 estimate, this company absolutely has to beat numbers. We think that’s the case this year, and to an even greater degree in FY(May)16.
The growth here is staggering. We should be looking at the law of large numbers, but we’re not. Growth is accelerating, and when all is said and done at the end of this year, Nike will have added enough revenue to equal the size of two Lululemons or 1½ UnderArmours. Nike’s success is a huge factor threatening job security for Adidas’ Herbert Hainer, who is looking on as Nike extends its lead in a seemingly unwinnable race.
But we think that there’s a bigger question to consider. Nike is tracking to put up a 46% Gross Margin this year. With increased growth in higher-margin e-commerce, which was up 70% this quarter (on an admittedly minute base of 4% of sales), growth in Nike retail (it has about 875 stores versus Adidas at 2,800), and manufacturing technology like FlyKnit that lowers manufacturing and excess materials costs, it is absolutely not unreasonable to ask the question as to when (not if) Nike’s Gross Margin will hit 50%. Keep in mind one thing…Nike accounts for warehousing and logistics costs in COGS, while most other brands book this in SG&A. This is a 5-point margin shift from SG&A to COGS. That means that on an apples to apples basis, Nike should put up a 51% gross margin this year – impressive by any stretch. That’s getting closer to ‘luxury’ than ‘athletic’.
All in, a 50% margin for Nike on $45bn in revenue -- where it is likely to be after the 5-years it would take to get there – gets to $8 in earnings power. Could there be added SG&A against that earnings number? Yes, you could never rule that out with Nike. But what kind of multiple is a 25% earnings CAGR and $8 in earnings worth for a blue chip name that is the dominant player in a global duopoly with 30% return on invested capital and a pristine balance sheet that could buy back $4bn in stock annually? It had a 24x p/e recently on financial characteristics that weren’t even close to what a 50% GM would bring. 25x? 30x? That’s $200-$240. Clearly, this is something of a ‘what if’ scenario, and it’s one that we would not see for another 4-5 years. That’s an eternity in this market. But we think that anyone seriously looking to invest in Nike today needs to be asking this question.
There are definitely risks here.
Nike itself is its own biggest obstacle. Every single time – without fail – that Nike has stumbled in the past, it’s been due to its own complacency. The organization does not seem complacent today. Quite the opposite, actually. But we keep this one on our front burner.
Another risk would be if Don Blair (CFO) were to step down. We have no reason to think that is on the near horizon, but Blair has been at Nike for about 15 years as CFO. We think that people underestimate how important he is inside the company, and how involved his organization is in the day-to-day operation of Nike. With the exception of certain talent in the design side of the organization, Blair may be the only person that is simply not replaceable.
We will be hosting our highly-anticipated Quarterly Macro Themes conference call on Thursday, October 2nd at 1:00pm EDT. Led by CEO Keith McCullough, the presentation will detail the THREE MOST IMPORTANT MACRO TRENDS we have identified for the quarter and the associated investment implications.
Q4 2014 MACRO THEMES OVERVIEW:
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We are adding BLMN to our Investment Ideas list as a long.
We've been saying for years that multi-concept casual dining companies are structurally flawed, putting them at a disadvantage to their nimbler counterparts. If history is any indication, Bloomin' Brands will need to sell its non-core assets in order to focus on growing the profitability of the Outback Steakhouse brand.
There have been several multi-branded casual dining companies that have needed to restructure, including Brinker International when it operated eight brands and, more recently, Darden which has already sold Red Lobster and likely has more changes on the way. Del Frisco's is another, much smaller, company that we suspect is structurally flawed and will face a restructuring in the future as it continues to grow and this becomes more readily apparent. And then we have Bloomin' Brands, who's day for restructuring is fast approaching.
Recall that OSI Restaurant Partners, the former operator of Outback, Carrabba's and Bonefish Grill, struck a deal to be taken private by an investor group comprised of Bain Capital Partners and Catterton Partners back in 2006 in order to focus on longer-term plans. This portfolio of brands re-emerged onto the public market in 2012 with a new name, but otherwise the same as it ever was -- a broken company.
We're calling for BLMN's board to come to grips with this reality and restructure the company. The good thing, in our view, is that there is a large, motivated shareholder (Bain) that has four seats on the board. They own 29% of the company which means they're likely laser focused on creating shareholder value.
In today's investment landscape, it's all a matter of timing. The board would be crazy not to consider value enhancing alternatives, but when they will do so is unknown. With that being said, there is a vast amount of investors with significant liquidity currently looking to deploy capital in the restaurant sector.
This is a portfolio of businesses that must be paired down to one (Outback) or two brands. This should immediately be followed by an aggressive effort to improve margins at the Outback business, which is significantly below its peers.
Bloomin' is suffering from the same issues that former broken companies have successfully remedied -- inefficient capital allocation. The Outback brand is so much larger than all of the other brands, that the 20th best idea for improving this business is likely more accretive to the bottom line of the overall company than the number one idea for improving any of the smaller brands.
These inefficiencies aren't always clear to outsiders, and we get that, but we guarantee they are clear to brands' Presidents. Internal capital allocation discussions typically go something like this:
Now imagine this discussion revolving around five different brands. As you'd imagine, internal politics can be a significant drain of energy and significant driver of inefficient capital allocation decisions.
It's easy for senior management to say the smaller brands are not a distraction but, at the end of the day, the overall business is not performing nearly as well as it should be. The fundamentals are dismal and this could continue to be an issue, but what we see is a company that is vastly undervalued on the public market. Based on our SOTP analysis, shareholders are essentially getting the Outback business at a discount and Bloomin's four other brands for free!
There is a real opportunity for the company to create significant value by selling off its non-core brands, improving operations at Outback and growing the brand internationally, where it has had tremendous success to-date.
Call or email with questions.
Hedgeye CEO Keith McCullough discusses the move into Quadrant 4 of Hedgeye's proprietary Growth/Inflation/Policy (GIP) model and what it means for the markets in this excerpt from today's Morning Macro Call for institutional subscribers. Quadrant 4 is where both growth and inflation slow.
This indispensable trading tool is based on a risk management signaling process Hedgeye CEO Keith McCullough developed during his years as a hedge fund manager and continues to refine. Nearly every trading day, you’ll receive Keith’s latest signals - buy, sell, short or cover.