Nike: Strong Tailwinds Approaching

Summary:

• Nike’s Q4 earnings report shows improved inventory levels, but this has affected operating margins. The company’s China business is also showing significant improvements, with sales growing 25% YoY.
• Upcoming sport-specific events, such as the women’s football world cup and the relaunch of the Kobe Brand, are expected to drive sales. The Jordan brand also shows potential for growth in international markets.
• The company’s valuation has also become more attractive.

Investment Thesis

Last time I talked about Nike Inc (NYSE:NKE), I talked about how the macro environment had finally caught up with the company and how the company’s management had not learned their lessons from the past when it comes to managing inventory. In this article, I highlight how this argument has become a thing of the past as evidenced by the company’s relatively healthy inventory levels. I also argue how the company’s strong performance in China along with specific tailwinds such as the women’s soccer world cup could be a timely boost for the company and its investors.

A Snapshot of Nike’s Fourth Quarter

The company had a mixed fourth quarter. Q4 revenues came in at $12.83 billion, up 4.83% year-over-year, beating analyst estimates by nearly $242 million. Diluted EPS came in at $0.66, missing estimates by $0.01 as the company’s efforts to manage its inventory levels ate into its margins. Q4 gross margins also dropped 140 bps to 43.6% as inventories were flat year-over-year, coming in at $8.5 billion. The company saw its in-transit inventory levels normalize and an improvement in the days-in-inventory metric, both on a year-over-year and on a quarter-over-quarter basis.

Despite the upbeat remarks from company management, the company’s FY24 guidance could be categorized as cautious at best, with FY24 revenues now expected to grow mid-single-digits and gross margins expected to grow by 140 to 160 bps.

Massive Improvement in Inventory Levels Comes at the Expense of Margins

One of the major takeaways from Nike’s Q4 earnings report was the improvement in the company’s inventory levels. Elevated inventory levels were a major headache for the company last year to see it coming in flat year-over-year is most certainly a positive sign. More specifically, the company saw the inventory of its apparel segment down 20% year-over-year and both North America and China segments saw their inventory levels down by high-single-digits on a dollar basis and by double-digits on a unit basis.

After initially attempting to put all its eggs into the DTC basket, the company’s decision to pivot back to wholesales, as evidenced by its recent decision to partner with Macy’s, should also help to keep its inventory levels in check in the future.

However, as mentioned earlier, managing inventory levels has not been pain-free, as the company’s efforts have come at the expense of a hit to its operating margins. And in the coming months, it does appear that it would be a case of how the company balances the additional catalyst of its wholesale partnerships against the macro environment that is going to be promotional in nature, which would determine the company’s performance. This probably explains why management came out with cautious guidance for FY24.

Nike’s China Story is Up and Running Now

After a significant period of subpar performance, NKE’s China business is starting to show significant improvements. Q4 revenues in the Greater China region grew 25% YoY, primarily driven by Nike Direct, which grew 19% year-over-year. Nike Digital, which has been one of the few bright spots for the company in recent times, actually saw a decline in sales by 12% year-over-year. This was not surprising given that China has only recently reopened following the pandemic lockdowns, which has led consumers to have a strong preference for brick-and-mortar over online shopping in the region. Operating margins, which were on a decline last year, grew 70% year-over-year on a reported basis, further demonstrating NKE’s ability to leverage the rebound being witnessed in the region.

The company also witnessed yet another record 18/6 event, the country’s annual shopping festival, as sales grew double digits. With the company planning more promotional activities in the region in the coming months, such as the company’s first-ever athlete tour in the region since the pandemic, Nike’s China story finally appears to be on the rise. Sustaining this uptrend will be crucial to the company’s future growth prospects.

Women’s World Cup and Jordan’s International Potential Offer More Tailwinds

In the coming quarters, there are a few upcoming sport-specific tailwinds for NKE. There’s the women’s football world cup in the summer, where the company features prominently, having partnered with “more federations in the tournament than any other brand,” which should help to drive the sales of the company’s latest women’s football boot, the Phantom Luna. Then there’s the company’s plans to relaunch the Kobe Brand ahead of Kobe Day on 24th August.

Finally, there’s the potential addressable market for the Jordan vertical outside of North America, where the penetration currently stands about 10 points lower. The Jordan brand, specifically, had an impressive FY23, registering an overall growth in the mid-30s, which sets it on track to becoming the second-largest footwear brand in North America. In the quarter gone by, Jordan unveiled its latest product, the Tatum 1, the lightest basketball shoe to date. The latest line, combined with NBA’s ambitions to grow internationally, should be a strong tailwind for Jordan’s growth in NKE’s international markets.

Valuation

Item	FY24 Projections	Rationale
Sales	$54 billion	Company estimates along with author’s projections
Gross Margins	44.9%	Company Estimates
Total Gross Profit for FY23	$24.25 billion	= 44.9% of $54 billion
SG&A Expenses	$17.4 billion	Company estimates along with author’s projections
Other Expenses	$250 million	Mid-point of Company’s Estimates
Tax Rate	18.2%	Company estimates
Total Net Income	$5.4 billion	= $24.25 billion – $17.4 billion – $0.250 billion
Number of Shares Outstanding	1.22 billion	Source: Refinitiv
Projected EPS	$4.43	= $5.4 / 1.22
Projected Forward P/E	28.3x	Source: Refinitiv
Target Price	$125.00	= 28.3 x $4.43

Click to enlarge

Source: Refinitiv, Author’s Calculations & NKE Q4FY23 Earnings Call

NKE now sees FY24 revenues coming in at mid-single digits. I have, therefore, assumed revenues to grow at 5% year-over-year, which translates to approximately $54 billion.

The company continues to expect gross margins to expand by 140 to 160 bps. Given the promotional environment that is expected to last for the foreseeable future, I am going to assume that gross margins will expand only by 140 bps, which translates to 44.9%.

The company’s SG&A is expected to grow slightly above revenue, so I have assumed SG&A expenses to grow 6%, which puts FY24 SG&A expenses at $17.4 billion.

Other expenses are expected to be between $225 and $275 million, so I have assumed the midpoint figure, which is $250 million. The tax rate is expected to be similar to FY23, which stands at 18.2%.

Combining all these figures results in a net income of $5.4 billion. According to Refintiv, the company has 1.22 billion shares outstanding, in terms of free float. This results in an FY24 EPS of $4.43.

The company currently trades at a forward P/E of 28.3x, which is not far from its historical median value of 30.5x. I have, therefore, assumed a forward P/E of 28.3x, and at this multiple, the price target for the stock is $125, which suggests an upside of approximately 15% from current levels.

Risk Factors

In addition to the retail environment being largely promotional in nature, there are other risks related to NKE for investors to consider. For instance, the company is currently being investigated by Canadian authorities over allegations of forced labor in China in the company’s supply chains and operations. This is one to watch out for in the coming weeks as any negative result could have wider repercussions for the company with respect to its China story. Then there’s the recent Supreme Court ruling regarding student loan payments, which could have a negative impact on discretionary spending in general, including on Nike.

Concluding Thoughts

Nike has come a long way since my last article on the company. It has done an impressive job managing its inventory levels and the company’s performance in China is truly commendable. Moreover, the company has strong tailwinds in the form of the Women’s Football World Cup and the upcoming Kobe Day.

Valuation is finally starting to look attractive, although post earnings, the stock does appear to have lost its momentum, as evidenced by the D+ rating on the Seeking Alpha Momentum Scale, which could result in some pullback in the short-term, thereby offering a meaningful buying opportunity in my opinion.

Overall, it’s safe to say that the company has got its mojo back, and from a long-term perspective, in my opinion, the stock has become investor-friendly again.

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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in NKE over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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