Overview of Nike Earnings, Leverage, and Valuation

Nike Inc. (NKE) has a positive earnings surprise history. In simple terms, positive surprise means that the company has beat Wall Street’s earnings estimates in the past several quarters. To be precise, Nike beat analysts’ earnings expectations in eight out of the last nine quarters. The company’s bottom line beat Wall Street’s estimates by an average of about 12% in the past nine quarters.

Notably, Nike’s profitability from growth in its high margin Nike Direct business. Moreover, the company’s ability to grow pricing supports margins and, in turn, its bottom line. Also, lower interest expenses led by low debt and share repurchases, and a lower effective tax rate support its earnings.

Nike has great growth momentum and started fiscal 2020 on a strong note. Nike’s first-quarter earnings beat Wall Street’s revenues expectations. This is thanks to the strong growth in the digital channel. Meanwhile, earnings beat analysts’ estimates. This was led by better-than-expected margins, share buybacks, and the lower tax rate.

The company’s first-quarter revenues of $10.66 billion rose 7.2% YoY (year-over-year). Also, first-quarter revenues beat Wall Street’s estimate of $10.44 billion. The company’s revenues continued to benefit from NIKE Digital. Also, sales improved across all geographies led by the digital channel.

In North America, revenues grew by 4%. Nike Digital revenues grew by more than 30% on a constant-currency basis. EMEA (Europe, the Middle East, and Africa) marked 12% growth with double-digit growth in NIKE Digital.

China continues to be a key growth driver for Nike. During the first quarter, sales in Greater China increased by 27% YoY on a currency-neutral basis. Nike’s revenues in Greater China have grown at a double-digit rate in 21 straight quarters. The region is a key earnings driver for Nike.

Strength in the high margin NIKE Direct operations and growing gross selling prices supported its margins. The company’s gross margins grew by 150 basis points during the first quarter and were better than its guidance. Robust sales and margin expansion drove the company’s bottom line higher, which marked high double-digit growth.

Moreover, a lower tax rate and share repurchases cushioned its bottom line. Nike posted EPS (earnings per share) of $0.86 in the first quarter, which beat analysts’ estimate by a wide margin and jumped 28% YoY.

Nike’s capex (capital expenditures) have slumped over the past couple of years. In the fiscal year 2019, capex shrunk by 10% YoY to $1.1 billion. Moreover, as a percentage of sales, capex has shrunk from 2.9% in the fiscal year 2017 to 2.6% in 2019.

The YoY decline in capex shows the company’s attempt to reallocate investments in digital platforms and a reduction in the store base. At the end of fiscal 2019, Nike’s has a total of 1,152 national and international retail stores, suggesting a YoY reduction of 2.5%.

The company, under its Consumer Direct Offense strategy, is growing its digital presence. Also, the company is accelerating the pace of innovation and speed to market. The Consumer Direct Offense strategy stepped up the pace of revenue growth despite a decline in capex. Also, digital remains the key revenue-driving channel for the company.

Besides accelerating the revenue growth rate, the company’s Consumer Direct Offense strategy is driving margins and supporting earnings growth. In fiscal 2019, Nike’s revenues grew by 7.6%. This is higher than the 6% growth it achieved in fiscal 2018. Plus, its gross margins expanded about 90 basis points.

The company’s future spending plans are focused on digitization and innovation. This plan could extend its competitive advantage. The company continues to allocate capital in new digital services and innovation. This is to enhance consumers’ experience.

Nike gets little leverage in its capital structure. The reason behind low debt in capital structure is that all of its manufacturing is carried out by overseas third-party contractors.  Outsourcing reduces the need for extensive levels of capital deployment. Independent contract manufacturers do Nike’s production. Moreover, the majority of its manufacturing takes place outside the US.

The company’s total debt stood at $3.5 billion at the end of the first quarter, ending on August 31. The company’s debt to capitalization ratio is 28.8%. The total debt to EBITDA (earnings before interest, tax, depreciation, and amortization) stood at 0.63. In comparison, Lululemon Athletica Inc.’s (LULU) capital structure has no borrowing whatsoever. Meanwhile, Under Armour Inc. (UAA) had $0.6 billion in long-term debt.

Nike stock trades at a premium when compared to most of its peers. Nike stock trades at 21.8x its next 12-month EV (enterprise value)-to-EBITDA multiple. This is above the peer group average of 17.0x. Adidas AG (ADDYY), VF Corp (VFC), and Under Armour stock trade at a forward EV/EBITDA multiples of 15.5x, 18.7x, and 20.1x, respectively. Meanwhile, Lululemon stock trades at a forward EV-to-EBITDA multiple of 24.8x.

Nike’s premium valuation, as compared to most of its peers, seems justified. Nike is the largest athletic footwear and apparel company in the world. Also, the company commands a strong market share. The company’s digital transformation, growth in direct operations, and product innovation bode well for growth.

Nike’s pricing power, lean manufacturing, and well-diversified supplier base keep it afloat despite challenges from higher tariffs. Looking at earnings estimates, analysts project Nike’s EBITDA to grow at a double-digit rate in the future. Meanwhile, Nike’s bottom line is expected to grow at a high double-digit rate.

Nike stock is up 25.5% so far this year. Also, the company continues to boost shareholders’ returns through dividends and share repurchases. Nike authorized a $15 billion four-year share buyback program in June 2018.

The company repurchased $2 billion worth of share under this program, as of August 31. Moreover, the company has raised dividend payouts in the last 17 years. The athletic apparel company is on track to raise it further in 2019.

To gain exposure in Nike stock through ETFs, one might consider Invesco DWA Consumer Cyclicals Momentum ETF (PEZ). Also, iShares U.S. Consumer Goods ETF (IYK), and Consumer Discretionary Select Sector SPDR Fund (XLY) provide exposure to Nike.

While the outlook for Nike remains strong, the company faces some risks that could hurt its earnings growth. Compared to its peers, including Lululemon and Under Armour, Nike gets a big portion of its revenues from overseas markets. It leaves the firm weak to both economic cycles in other geographies and adverse currency movements. Either of these variables could lower Nike’s profits.

The athletic products market is competitive and could hit Nike’s growth. Although Nike leads the market by a wide margin, tough competition and changes in technology pose threats. 

Also, higher-priced products make Nike weak to consumer preferences. Although the company proved to be relatively resilient in the most recent recession, an economic downturn could reduce demand and unit sales. This would hurt Nike’s earnings.

Almost all its manufacturing goes to independent contractors in overseas countries, including Vietnam, China, and Indonesia. It makes the company vulnerable to changes in government policies, including higher tariffs.