Oddly, Nike (NKE) rallied to new highs following strong FQ3 results back in March as the market ignored the impending COVID-19 impact. The prior quarterly report ended in February and the market appeared to incorrectly interpret the limited virus impact in the quarter. The market didn’t apparently realize the last quarter didn’t feel the full impact. My investment thesis remains negative on Nike at this valuation as the market comes to terms with the weaker results.
Nike jumped all the way to over $105 in early June after dipping to $60 in the middle of the pandemic. The athletic apparel retailer had the majority of their stores in North America and EMEA closed in the quarter causing the stock to hit a major double top at the recent highs.
Though analysts cut revenue estimates, the numbers weren’t anywhere close to reality. Since March, the quarterly revenue estimates were cut from $11.1 billion to $7.5 billion prior to the earnings release, but the numbers were still off by nearly $1.0 billion with Nike only printing $6.3 billion in sales for the May quarter.
Source: Seeking Alpha earnings revisions
The market clearly misunderstood the ability of the athletic apparel retailer to shift sales online and the desire of consumers to purchase athletic gear with sports virtually shutdown through May. Online sales grew 75% in the quarter, but the amount only reached $1.9 billion for 30% of total sales. Also, Nike had an unexpectedly strong FQ3 so the market possibly misunderstood how that quarter ended in February allowing the company to skirt the North American and Europe hit in the prior quarter.
Nike is still highly dependent on retail stores and wholesales partners. The weak sales left the company with $7.4 billion in inventories, up 31% from last year. Gross margins were hit by the reduced sales with margins down 820 basis points to 37.3%. GAAP earnings missed analyst estimates by an incredible $0.54 and Nike will face another touch quarter with the high inventory balances.
While the numbers aren’t surprising to those investors paying attention, the market was clearly off target here. Other retail stocks aren’t trading anywhere near all-time highs with revenues down this much.
The company quit share buybacks during March in more of a sign that the stock got expensive. Nike ended May with $12.5 billion in liquidity and $8.8 billion in cash suggesting the company had plenty of cash to purchase shares, if value had existed once the economy started to recover in May.
The major issue is the valuation here. The stock trades at 30x more normalized FY22 (May) EPS estimates. These numbers may even take a hit after the weak FQ4 numbers.
So again, Nike has historically aggressively repurchased shares, but the issue in the last quarter wasn’t the virus. The company could’ve easily spent $1 billion on share buybacks with the forecasts for sales to bounce back, but the stock immediately surged back to above $80 by the end of March providing limited motivation for aggressive buybacks.
The company remains bullish on China returning to growth and digital sales reaching 30% of sales in normal times. While these projections sound bullish, the market opportunity just isn’t large enough to push sales growth above 10% for a retailer with $85 billion in sales last year.
The key investor takeaway is that the stock remains far too expensive for the market opportunity in a competitive athletic apparel sector. Nike has already rebounded to all-time highs, but the estimates for the next year don’t even approach the record levels from FY20.
Investors should exit the stock and wait for a pullback following weak earnings.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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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Originally published on Seeking Alpha