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Don’t Get Too Excited About Nike Stock Just as the Rally Begins Fading

Luke Lango

Nike (NYSE:NKE) is in blast-off mode after the company reported robust quarterly numbers which were highlighted by a return to growth in the critical North American market and strong growth in the company’s direct channels. As a result of those strong numbers, Nike stock soared more than 10% to all time highs.

Nike now sits above $80, and everyone is calling for more upside. A few months ago, in October 2017, Nike was trading around $50, and concerns ranging from Adidas (OTCMKTS:ADDYY)competition to North American market saturation were running wild.

In other words, the Nike narrative has made a huge pivot over the past several months. That pivot has been supported by improved numbers, and Nike stock is at all time highs as a result.

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But I think now is the time to exercise caution. There are some serious operational risks materializing on the horizon. While Nike will remain king of the athletic retail world, the go-forward numbers won’t be good enough to support the current stock price.

As such, I think it is time to fade the rally.

Here’s a deeper look.

Nike’s Quarter Was Outstanding, as Expected

There’s no other way of saying it. Nike’s quarter was simply outstanding.

Revenues rose 13%. Nike brand revenues rose 9%, one of the best growth rates the Nike brand has seen in several quarters. Nike Direct revenues were up double-digits, underscoring that the company’s pivot to direct selling channels is working.

North America revenues, which have been in decline for several quarters, flipped to positive growth in the quarter (+3%). Gross margins, which had been in retreat for several quarters, flipped into expansion mode and expanded 60 basis points year-over-year.

In other words, Nike’s quarter flipped the script on many narratives for the athletic retail giant. The declining North America business is now a growing North America business. Gross margin compression is now gross margin expansion. Nike wholesale weakness is now Nike Direct strength.

That is all really good news. And it is a testament to just how powerful and valuable the Nike brand is. Competitors like Adidas and Under Armour Inc (NYSE:UAA) have tried time and time again to knock Nike off its throne. But such attempts never prove successful. Nike always adapts, and always wins in the end.

This time is no different. Adidas was kicking Nike’s butt for the past several years thanks to a return to retro styles and a broad lifestyle approach to athletic retailing.

Nike has streamlined investments to be at the frontier of new trends, pushed product innovation to always have the newest and coolest sneakers on the market, created a robust direct sales channel, and made a similar pivot to a being a lifestyle brand.

The net result? Nike is growing again. And that is why Nike stock is roaring to all time highs.

Nike Has Big Risks Going Forward

But at these levels, Nike stock is a buyer beware situation.

Earnings next year could very well shake out around $2.80 (current estimate is $2.68, but that was before the quarter’s robust results). That means that at $80, Nike is trading at around 28.6-times forward earnings. That would mark a 5-year high forward earnings multiple, and is 18% bigger than the 5-year average forward multiple of 24.3.

In other words, Nike stock is presently priced for super-charged numbers.

Unfortunately, I don’t think Nike will deliver those super-charged numbers. Adidas competition has cooled off tremendously, but it’s still there. Just look at Google Trends. Adidas has gained tremendous mind share on Nike over the past 5 years, and while those mind share gains have moderated recently, the gap between Adidas and Nike search interest also hasn’t noticeably widened.

Moreover, Adidas just stole rapper Drake from Nike, and that is big boost to the lifestyle appeal of Adidas. All together, then, the Adidas threat is far from dead.

Also, on the basketball front, there is a new competitor emerging with surprising momentum. The competitor is Puma. They just signed the number 1, number 2, number 14, and number 16 picks in the 2018 NBA Draft to shoe contracts. They also announced Jay-Z as creative director, a move which should help them sign more stars.

And they are sponsoring “The Basketball Tournament,” a basketball tournament televised on ESPN that has a $2 million take-home prize and features former-pros.

In grand total, tiny Puma isn’t a threat to big Nike right now. But going forward, if Puma keeps this momentum up, Nike basketball will obviously take a hit.

Bottom Line on Nike Stock

Nike stock is soaring to all-time highs because the numbers right now are really, really good.

But the stock is priced for these robust numbers to continue to be robust over the next several years. I don’t think that will happen. Adidas is still a very big threat and Puma has all the sudden caught fire in the basketball market.

As such, perfection won’t happen for Nike over the next several quarters, and lack of perfection could short-circuit this rally in Nike.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities. 

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