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Takeaway: Here's a graphical overview as to why we think this quarter is Nike's Greatest Of All Time.
We welcome anyone to challenge our statement that this is the best and most impressive quarter in Nike’s 35 years as a public company. Our rationale is below. But whenever any company’s performance is so mind numbing – both on an absolute basis and relative to expectations – one has to wonder if there’s room to go. Is this the time to peel some off, or sell outright? The stock closed Thursday at a $99.2bn market cap. It flirted with $100bn only twice before. But Friday it will hit the triple digits, and the question is whether it will fall below $100bn ever again. We’re going to answer that question in depth when we release our Nike Black Book on October 12th (two days before the analyst meeting). But our initial sense is that the best is yet to come.
Interestingly enough, the only negative in the quarter was a high level of inventories in the US. This will be nothing more than a hiccup for Nike, but it should absolutely slow growth, or impact margins for Retailers like Foot Locker and Hibbett, two of our top shorts.
Here’s why we think this quarter is Nike’s #GOAT… (note: not all of these factors are at historical peaks, but collectively, they paint a GOAT picture).
1) Growth Algorithm. 5% top line, 7% gross profit, 17% EBIT, and 24% EPS growth. It’s tough to ask for more from a $33bn revenue company. Moreover, check out the chart below which shows that directionally, the company had a nearly identical Algorithm five quarters in a row. The number 5 is very important, because it ‘comped the comp’. There’s nothing stopping it from getting to 6, 7 or 8.
2) EBIT Growth. Despite only 5% revenue growth, this was the second largest EBIT growth quarter in Nike history as measured in incremental dollars – something that should technically not be happening in the heart of a down-cycle in FX.
3) Pure Unadulturated Growth. Seriously…this company just put up a 17% (currency neutral) futures number. We’ve only seen that once before over the past 10 years, and that includes a time period (’05) that had $20bn less in revenue. Growth should be slowing, but someone forgot to send Nike that memo.
4) Let’s put this growth into context. First off, nearly every geography and most categories are growing double digits – all at the same time. The only real negative callout is Emerging Markets. This has been a gripe for us over the past year. Last we checked, Emerging Markets are supposed to ‘emerge’ as opposed to grow at half the rate of mature markets like the UK and US. Every sport is up for Nike except for Football due to a hangover from World Cup last year (we’ll give a pass on that one). If we look at the implied dollar value growth over the upcoming futures window, that’s about $2.6bn. If you annualize it, it is the size of UnderArmour and AdiBok’s US business combined.
5) Currency Immune? Nope. The chart below shows that revenue is doing exactly what it should be doing given FX pressure. But EBIT is not. We still think it’s amazing that nobody questions why gross margins are positive despite the negative hit in FX. In every single past FX downcycle back to the time it started to sell outside the US in earnest (circa 1990), Nike’s margins got hit dramatically due to FX transaction impact. Did the company acquire a black box to hedge better? No. Is it making more product locally? No (though that should soon happen). The stark reality is that the massive growth ramp in e-commerce is materially padding margins – much more so than the company casually admits on the conference calls. Consider the following math. If we assume that e-comm and DTC growth (which grew at 46% and 21%, respectively in the quarter) was in line with the company average at 5%. With implied margins at e-comm of 70% and DTC of 50% that means that the base business was down 38bps in the quarter with outsized DTC growth driving 125bps of the margin change.
6) RNOA Looks Solid. While not perfect, due to higher inventory levels, the overall trajectory of RNOA is outstanding – sitting at 42%. As a reminder, this analysis looks at the only two things that consistently drive value creation for consumer brands and retailers – 1) tax adjusted operating margins x 2) operating asset turns. A company can usually improve any one of those in any period, but can rarely improve both at the same time. Nike is better than any company we’ve ever seen in driving value in this regard.
NKE | New NIKE Black Book
Takeaway: We’re issuing a detailed Black Book on Nike just ahead of its Oct 14 Investor Day, and will dive deep into all the key issues as we see ‘em.
There’s going to be several key areas of focus for Nike in the three weeks between NKE’s print this evening, and it’s Analyst meeting on October 14th. As such, we’ll tackle them prior to the analyst event in a deep dive Black Book and presentation on Monday, October 12th at 1:00pm ET. Key issues include…
1) Global growth algorithm – how will today’s building blocks be different in 1, 3 and 5 years.
2) US Distribution -- how much runway exists for Nike to profitably grow in the US.
3) ASP Cycle -- Where are we, what keeps it going higher, and where’s the downside risk.
4) e-commerce – why Nike sandbagged on its targets, and will sandbag again.
5) GM%: Why a 50%+ Gross Margin is achievable for Nike
6) China: How weakness in the Chinese economy could affect Nike’s growth
7) Athlete Endorsements – we’ll look at returns on athletes, which are largely diminishing
8) Competitive Landscape – especially in the US. Also how customers are becoming competitors
9) Investor Meeting: How this analyst meeting should be different from others.
Call details will be provided one week prior to the call.
Takeaway: At $8 PIR is trading at 6.5x p/e, 0.4x sales, and 3.5x EBITDA on 2018 #s. We’re willing to stomach the near-term pain with numbers like that
If everyone wants to get bent out of shape on a 2% top line miss for a company that’s been struggling for the better part of 3-years, then they can be our guest. With a beaten-up value stock/show-me story like PIR, we need to see it go, in order, through the four critical stages of retail recovery. Those are 1) capex cut, 2) working capital improvement, after which we can begin to see 3) margin improvement, which will, in turn fuel 4) revenue growth. A company like this can’t go straight from “will it stay in business?” to “accelerated top line growth”. That’s simply not how the retail world works. The company’s capex will be down by 27% this year, we just saw a 16 percentage point positive swing in its sales to inventory spread (see SIGMA below), and that sets up for meaningful margin recovery in FY17 (which starts in four months). Along the way, we’re still seeing a comp of 2-3%, which ain’t half bad. We still think a year from now people will be looking at $1.25 as very realistic and achievable earnings power for PIR. That implies that at $8 the stock is trading at 6.5x earnings, 0.4x sales, and 3.5x EBITDA. We’re willing to stomach the near-term pain on this one with numbers like that. On the way back up, it’s not unrealistic at all to get to a stock well above $20 if our numbers are right.
More Details on the Quarter
09/24/15 09:21 AM EDT
PIR | LONG WALK ON A SHORT PIR
Takeaway: This is a great name to buy on an ugly print. Ugly qtr, but financial recovery finally within reach.
We’re not expecting a whole lot of positive news from PIR’s 2Q print (today after the close). EPS is a moving target, and guidance will be light. But when all is said and done we think that the results will show that the financial and operational inflection point for this beaten-down value stock is finally within reach. Are we concerned about a headline miss later today? Yes. We were well aware of these concerns when we added PIR to our Best Ideas list on August 31. Furthermore, we have yet to talk to anyone about this name that is not expecting an ugly quarter. Several analyst notes have already come out calling for a miss, and on top of that, short interest has raced up to 16% of the float – a four-year peak. We think they’ll ultimately be proved wrong.
A key consideration is that CFO Jeff Boyer will handle guidance for the first time after joining the company in late July. It’s not entirely clear how he will handle guidance…but we can’t imagine that he’ll want high targets his first year on the job. We’ve heard this concern from bears as well “new CFO will lower the bar”. Maybe we’d be concerned if the stock was up 20% over the past quarter, but we’re looking at quite the opposite – a 26% decline since the last earnings report in mid-June, and 12% over the past month. So will guidance be lower? Probably. But it’s very important to note that Boyer is likely to lower because he wants to, not out of necessity.
Why We Like It – PIR is a beaten-up, ugly value stock…there’s no two ways about it. But with the stock trading at just 0.5x sales – a level it hasn’t sustained in six years -- we think there are two primary questions to ask. 1) Are we going into a major recession? and 2) Is management going to do anything more destructive that would otherwise emulate a major recession? If you answer ‘No’ to both of those questions, then we think it’s a very good risk/reward to buy the stock with $3-$4 down and $20 upside.
1) We have some major questions marks as it relates to the economy, but we’re not calling for an all-out recession.
2) This is a company that is no stranger to execution issues, but we don’t think that management is about to do anything more that would cause a downturn in the business (especially w/ new CFO taking the seat in late July). Quite the opposite, in fact. Consider this…
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