Nike Is In It For The Long Run

We recommend a buy for Nike (NKE) as it exhibits a strong revenue growth, steady fundamentals, successful share buybacks, and a consistent lead in the industry mostly in terms of valuation. The freshly released fiscal Q1 report reiterated and surpassed analysts’ expectations on revenue and EPS.

PROFITABILITY

Nike posted EPS of $1.23 compared to analysts expected $1.12, and last year Q1 EPS of $1.36. Revenues of $6.70 billion were reported in contrast to earlier estimates of $6.42 billion, or 10.2% more than the sales of the same quarter last year. Last quarter, the company had missed the Street’s estimates for revenues and EPS. Nike revenues increased in all segments and across all geographical areas except in Japan and in licensing.

North America and emerging markets are the substantial drivers of growth with 23% and 22% revenue growth respectively as compared to last year’s quarter.

High input costs, direct distribution of Converse to China, and a renewed focus to lower margin businesses pushed the gross margin lower by 0.8 percent. Nike’s promotions through the Olympics and European Football Championships increased selling and administrative expenses by 18%, a higher rate than revenue growth. This expense is 29% more than last year. Nike deliberately diversified Cole Haan and Umbro businesses due to their losses. Except for these businesses, EPS would have been $1.27 (4 cents higher). Analysts continue to estimate an 8% earnings growth rate for the next 5 years.

Nike anticipates a 6% growth in future order including exchange rate effect and 8% without the exchange rate effect. This estimate is largely influenced by the current Europe instability. However, North American orders are expected to grow by 13%. Like many other apparel and footwear companies, Nike faces pressure due to weak economic conditions, both in the U.S. and Europe.

SHARE BUYBACK PROGRAM

Nike recently completed the $5 billion share repurchase program, ans subsequently announced a new program on September 19. NKE is authorized to purchase $8 billion of Class B common stock in four years. The company’s market cap is $43.7 billion, and there are 361 million Class B shares outstanding. The cash equivalent balance was $2.16 billion as of Q1 FY2013. The company has a dividend yield of 1.5%.

VALUATION AND GROWTH

At NKE’s 5-year average P/E of almost 18x, and $5.89 EPS estimates for 2014, the share price comes out to be $106. The 52-week high is $114.

While in the short run, Nike will face pressures due to economic conditions in Europe, and slow growth in China, we recommend buying NKE for its long-term potential because the company is continuing its focus on its more profitable businesses. It also has fundamental strength and wants to continue to return value to investors through its $8 billion repurchase plan and dividends.