Nike: The market is still open

Clothing giant Nike Inc. (NKE, Financial) is down slightly since late May when I wrote that the sharp fall in the share price made the stock look more attractive. The 37% decline in value year-to-date has hurt shareholders, but Nike remains one of the best companies in its industry, backed by strong brands and strong fundamentals.

The stock is trading at a large discount to its intrinsic value and is forecast to return to high growth in the near future. The company also boasts several decades of dividend growth. Let’s take a closer look at Nike to see why the stock could represent a great entry point.

Company background and current results

Nike has one of the most recognized brands in the world. The company regularly tops lists of most valuable brands and is often the only apparel company to do so. That’s because Nike’s reach is wide, fueled by key partnerships with top athletes and a healthy advertising budget that typically tops out at around $4 billion a year.

Partnerships and endorsements have allowed the company to grow into a $163 billion behemoth that often eclipses the competition. For example competitor Adidas AG (ADDY, Financial) and Under Armor Inc. (u.a, Financial) have a market cap well below that of Nike.

The last quarter was a bit mixed. While revenue fell 0.9% to $12.23 billion, that was mostly due to a strong U.S. dollar. Additionally, the results were still $140 million ahead of Wall Street analysts’ expectations. Currency-adjusted revenue increased 3% for the quarter. Net income improved 5% to $1.4 billion, but earnings per share fell to 90 cents from 93 cents. This was still 9 cents above expectations.

For the fiscal year, revenue increased 5% to $46.7 billion, net income improved 6% and earnings per share to $3.66 compared to $3.56 in fiscal 2021 Reminder: The previous fiscal year showed incredible growth from which the company’s markets had strongly recovered from the worst of the pandemic. Revenue nearly doubled in fiscal 2021, while earnings per share rose 123%.

The company had some weaknesses in the quarter, particularly in North America, where revenue fell 5%, and in China, where revenue fell 19%. The results were impacted by supply chain restrictions in these regions and, in the case of China, by Covid-19 restrictions.

Elsewhere, the results have been fairly positive. Gross margins for the year increased 120 basis points to 46% as discounted items were limited amid high consumer demand. Wholesale fell 1%, but most other channels saw growth. Nike Direct grew 14%, with Nike branded digital sales up 18%. Captive stores grew 10%. By region, Asia Pacific and Latin America grew 15% and Europe, Middle East and Africa grew 9%.

Despite weakness in key markets, earnings per share increased year-over-year. Analysts covering the company expect fiscal 2023 to be similar to last year, with earnings per share expected to be $3.73, according to Yahoo Finance. Higher wages and a strong dollar are likely to weigh on results again. However, analysts expect that pain to ease going forward as earnings per share for fiscal 2024 are forecast at $4.52.

Ranking compared to peers

Nike may not see significant earnings growth until 2024, but the stock is still one of the most highly valued in its industry.

The company has the potential to outperform based on its GF score of 92 out of 100 given its high marks on profitability, financial strength and growth.

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Nike receives a 9 out of 10 for profitability from GuruFocus. As mentioned above, the gross margin is extremely high and better than three quarters of the apparel industry. The latest result is at the upper end of the company’s 10-year history. Consumers are willing to pay full price for Nike’s products, which should support a higher gross margin.

The importance of profitability also results from high returns on equity, assets, invested capital and capital employed. All scores in these areas are the best of at least 92% of peers. Nike has achieved profitable results for 10 consecutive years, which is better than 99.91% of the competition and shows how well the company’s products are received by consumers.

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The company’s financial strength rating is a solid 7 out of 10, which is immensely supported by a return on invested capital of 32.3%, which far exceeds Nike’s weighted average cost of capital of 7.2%. Nike is among the best when it comes to providing a strong return on your invested dollar. Debt has risen sharply in recent years, but the company has very high interest coverage, which tops 75% for the industry. Due to the higher level of debt, the debt-to-equity ratio is less than two-thirds of its peer group, and the cash-to-debt ratio is near the low end of Nike’s performance over the past decade.

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Nike’s growth rank is 9 out of 10, with three-year book growth and three-year sales growth being the main reasons for the high ranking. Almost everywhere else, the company has midfield appearances. The only exception is future earnings, as the company is expected to grow nearly 10% over the next three to five years. Future earnings per share growth is forecast at 12%, which would be in line with the company’s compound annual growth rate over the past decade.

Dividend Safety Analysis

Nike shares are yielding a paltry 1.1%, even trailing the 1.6% average return for the S&P 500. Most investors are probably holding the stock for its growth potential, since over the past five years, shares are up almost 100% since the beginning of the year, even after falling in price.

Still, Nike’s earnings aspect is important, as the company has shown it can increase its dividend regardless of economic conditions. The company’s dividend growth streak is 20 years. Over the past decade, the dividend has experienced a CAGR of 12.2%, which aligns very well with earnings growth. The company increased its dividend for payment date December 28, 2021 by 10.9%.

Last fiscal year, the company paid a dividend of $1.16 per share, which translates to a payout ratio of 32%.

Investors should see a dividend of at least $1.22 per share for fiscal 2023, giving Nike a projected payout ratio of 33%. For comparison, Nike has a 10-year average payout ratio of 33%.

As far as free cash flow goes, the dividend also looks safe. Last year, Nike paid out $1.83 billion in dividends while generating $4.43 billion in free cash flow, a payout ratio of 41%. That’s slightly higher than the three-year average payout ratio of 36%, but not enough to make dividend security a concern.

Another area of ​​concern is the company’s debt and how that could affect its ability to continue paying and increasing the dividend.

Nike’s trailing-12-month interest expense was $205 million on total debt of $12.63 billion, giving the company a weighted average interest rate of just 1.6%. This is one of the lowest weighted average interest expense of any company I’ve researched.

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Source: Author’s calculation

Nike’s weighted average interest rate would have to be above 22.1% before free cash flow couldn’t support its dividend payouts. With the current interest rate so low, it seems highly unlikely that debt obligations will negatively impact Nike’s dividend anytime soon.

Valuation Analysis

The share price drop means Nike is now trading at a significant discount to its intrinsic value, according to the GF Value chart.

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Nike closed Friday’s trading session at $104.44. Currently, the stock has a GF value of $142.76, resulting in a price to GF value ratio of 0.73. Reaching the GF value would mean a price gain of 37%. The stock is classified as slightly undervalued.

Final Thoughts

Nike’s most recent quarter was a mixed bag, but the company still managed to grow compared to the previous fiscal year. The company continues to enjoy strong consumer demand despite weakness in certain regions. Analysts aren’t expecting much growth for the coming fiscal year, but Nike is likely to return to its usual high-growth nature after that.

Beyond recent results, Nike’s GF score shows that the company has the potential to generate a sizeable return, which is backed up by the stock’s GF value. The company ranks highly on a number of key metrics relative to its peers. The dividend may not be generous, but the dividend growth streak and CAGR are impressive.

Given the strength of the company’s metrics and its industry-leading position, the market may have mispriced Nike’s shares based on short-term results. This could provide the opportunistic investor with a good entry point into the name.

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