If you’re one of the half dozen people who can look through any form of near-term volatility – then congratulations. You can stop reading this now. If you’re part of the other 99% who has to at least carry an umbrella when there’s rain in the forecast, then read on.
My phone always rings off the hook in advance of Nike’s print. One thing that’s different this time around is that I’m worried about the event. Don’t get me wrong -- I think fundamentals look great. I’m at $1.08 vs. the Street at $1.01. Futures look fine. The business is in check, and I remain convinced that estimates for the next 2-years are 10-15% too low.
If you’re one of the half dozen people working at a shop that completely looks through any form of near-term volatility – then congratulations. You can stop reading this now. If you’re part of the other 99% of the population who has to at least carry an umbrella when there’s rain in the forecast, then consider these factors.
From a near-term perspective...
- We all know that this is a company that HAS TO beat numbers. This is Nike, after all -- exceeding expectations is what they do (and how they’re compensated). We’ve had some analysts come up to our EPS level, and salespeople at one major buldge-bracket Firm going out with a message that this will be a ‘blowout – i.e. between $1.14ish ps’ quarter.
- Then there was a very bullish preview by another major Firm who laid out the case as to why this is such a great three-year call. Some of the verbiage around the drivers and cadence of growth at Nike was conspicuously spot-on (to the extent that one client called me at 7am that morning laughing) with what we came out with in February when Keith first added Nike to the Hedgeye Virtual portfolio. Dare I say that the call from 9-months ago has become the consensus?
- Sell-side sentiment is extremely bullish, with only 3 months over the past 5-years where the Street was more positive. (See chart below).
- Short interest is near all time lows of 2.5% of float. The one saving grace is that management stock sales have been minimal since spring. That’s a good sign; actually, as this management team is not afraid to sell stock when the time is right (restricted stock and options play a major role in executive compensation).
- FX is not a disaster – but based on our proprietary index of Nike’s sales by country vs. blended forex rates, NKE is about to print a quarter that includes the most unfavorable second derivative in FX since summer of 2008. Assuming current rates prevail, we’ve got another quarter of slight erosion, then a slight pickup in 3Q.
- As it relates to guidance, keep in mind that Nike is far less impacted by industry margin pressure than the average company in retail given a) disproportionately low cotton exposure, b) better supply situation in Asia associated with footwear, c) better R&D cycle helping demand for footwear in the US, and most importantly d) simply having a superior brand with pricing power that just stripped the ball from the QB and is once again on offense. But mark my words, the simple fact that these outside pressures exist will be all management needs to point to in order to get expectations to be beatable in 2Q.
- Lastly, keep in mind that today we’re looking at a sales + GM improvement story. But as the year progresses and GM improvement eases on the margin, Nike starts to get SG&A leverage as it anniversaries the World Cup. Then it also starts to benefit from better non-operating income due to the mark-to-market of its FX hedges. My sense is that there less room for error from a valuation perspective when it’s a sales + SG&A +other income story as opposed to sheer sales and GM improvement.
Synching With the Long Term Call
Perhaps I’m being a bit too anal (can I use that word in a note? Wikipedia says Yes) around unusually positive near term sentiment factors. The reality is that this story dwarfs most others in Global Consumer as it relates to the company’s ability to grow profitably and consistently.
Yes, the sentiment is bullish, but I still think that many longer-term investors underestimate the real 3-year call here.
I think that people ‘sort-of ‘get whole concept of how Nike is changing its ‘go to market’ strategy, and how it impacts the business at wholesale, retail, and dot.com. Same goes for global impact on top line.
Do people get the upside in GM% as Nike executes? I don’t think so.
The kicker is this… The average ‘long and strong’ PM I talk to that is scared about the consumer and looking for something to own out there still gets a bit of a ‘wide eye’ factor when we collectively lay out the long term call. “This is the leader of a global duopoly in a GDP plus industry that is about to see considerable strengthening in its structural low cost advantage. Why? Nike has outsized sales exposure to China, while having disproportionately low cost exposure. Case in point… Of Nike’s $10bn in COGS, only about $2.6bn are Yuan-denominated. Yet the company has close to $2bn in sales in China. That gap is narrowing, and should be closed within 2-years. That would make Nike one of the only Global companies that would have a structural sales and margin benefit as the Yuan floats higher.” When you can point to an improving R&D cycle, consensus numbers that are too low by 10-15% in each of the next 2-years, and $5bn in net cash on the books, this name is a pretty darn safe place to be.
The punchline? If you have an umbrella, definitely keep it handy over the next 24 hrs. Sentiment is so bullish – but for some of the wrong reasons. You might have an opportunity to buy more of an underappreciated story at a lower price.