This is one of those good news/bad news quarters for Nike. I’m on the ‘net less bad’ side. And to be clear, I’m bullish on the name over a TREND and TAIL duration. I’m not hedging that positioning with one of those ‘buy on weakness if I’m wrong’ calls. Bc the fact is that if I’m wrong on the fundamentals, there’s got to be a thesis changer on the TREND side, which takes what is otherwise a $55-$65 range-bound stock back to the low-mid 50's in a heartbeat. I’m willing to take that risk based on what I see today.
- On the plus side, EPS delta likely to beat by $0.04, or 10%, with revenue stabilization globally, and gross margin beat for the first time in six quarters. (see puts and takes by quarter in first Exhibit below).
- The bad news is that the quality of earnings is still horrible. Revs +4%, Gross Profit flat, and EBIT down 12% (street and guide at -20%).
- The company is highly likely to keep the (May) year even, so bears will have a narrative that sounds like…
- “yeah…beat w horrible quality earnings and now we have an even bigger hockey stick EPS algorithm expectation for the next two quarters. There’s your multiple pressure.
- It’s still losing share to Adidas in the US – albeit at a decelerating rate – and it’s carrying 2x the EV.
- Stock is +18.2 since the last print (S&P +7.3%) and though short interest is the highest since the great recession, it’s still sitting at just 3.5% of the float.
- If you’re bullish, have fun staying long unless we see a fundamental turn in the business.”
Key Modeling Assumptions
- It’s clear that the Western Europe business is accelerating – based on results out of the channel. Ditto for Asia. Gross Margin's have been mixed (especially at Sports Direct in EMEA) but are at the expense of clearing inventory to take on new product into CY18. Tourist markets picking up – and unless NKE is becoming TIF – which it’s not – there should be a benefit there.
- The 7% downdraft in US high-price-point basketball is likely to stabilize. I’m concerned about running, actually – but with an unfavorable 20% price point spread, I’m ok with that. Could be FL bullish – though even a basketball shift higher can’t save margins given what’s coming down the pike from Nike and UA.
- DTC likely to trend up closer to 20% (from mid-teens) -- adding 1-2 points to rev on a ‘share agnostic’ basis (if such a thing exists).
- GM puts and takes suggest a 35bp beat, unless ASP falls further than 2-3%, product costs can’t lap a ridiculously easy (i.e. 3-year peak – printed last 2Q/3Q) and FX hit is more than 100bp. I don’t think these expectations are aggressive.
- Wildcard is that CO guided to SG&A +ldd, and I’ve got it +9%. The operating overhead assumption built into the company guidance looks too conservative – espec in light of headcount reduction, so if I’m wrong, it’s likely to be w higher Demand Creation. To be clear, there’s no better harbinger for rev growth than higher DC – so I kinda want to be wrong on this one ie higher SG&A spend = a winner over TREND and TAIL.
- Tax rate likely to be down by 1,000bp and EPS STILL guided to be -20% vs last year. Great quality there guys (not). Still, I’m looking for a 10% EPS beat.
- Share count -2% sequentially – nothing heroic, but golf clap on balanced distro of repo/cash build (meh re ROIC vs ROE trade) and dividends.
Keep in mind one thing, when revenue stabilizes, GM inflect, orders end bottom process, and working capital corrects on the margin – DO NOT BE SHORT THIS STOCK. In fact, find me an example historically when that event did not precede a 20% move in the stock over the following 3 months.
GROSS MARGIN PUTS AND TAKES
