Shares of Nike (NYSE:NKE) dropped sharply on March 22, after the global athletic apparel giant reported mixed third quarter numbers that, while topping consensus Street estimates, showed signs of a recovery slowdown. Investors weren’t prepared for that and NKE stock lost more than 5%.
Specifically, Nike beat both revenue and profit estimates in the quarter, while giving an upbeat forecast for the fourth quarter and next year. But, growth rates across the board slowed sequentially, and the guide calls for further deceleration next quarter.
In the big picture, this post-earnings sell-off in Nike stock is nothing more than a healthy reset. The stock was really hot heading into the print, trading at all time highs and up more than 20% over the prior three months. Nike needed to report excellent numbers across the board to justify the pre-earnings rally, and by excellent, I mean “better than last quarter’s numbers”. They didn’t. The numbers got worse quarter-over-quarter. The stock dropped.
But, the numbers are still very good here. Revenues still rose by more than 10% in constant currency. North America revenue growth remains healthily positive. Gross margins are still expanding. Further, the guide calls for all this things to largely continue for the foreseeable future.
Essentially, while the Nike growth narrative is slowing, it’s still very positive. As such, once the dust settles from this sell-off, NKE stock will resume its longer term march higher.
The Quarter Was Still Good
Judging by the stock price reaction, one would think that Nike’s third quarter earnings report and fourth quarter guide were awful. They weren’t. Instead, the quarter and guide were actually very good, and broadly underscore that Nike is still firing on all cylinders.
Why the huge sell-off in Nike stock? Because things – while still good – are slowing. Revenue growth slowed from 14% last quarter, to 11% this quarter, and is expected to go below 10% next quarter. North America revenue growth slowed from 9% last quarter, to 7% this quarter. Europe, Middle East, and Africa revenue growth slowed sequentially, too. So did China and Asia-Pacific revenue growth.
But, this slowdown is being blown out of proportion. Keep in mind, Nike is a $40 billion revenue company in the athletic apparel space. That’s huge. Peers Under Armour (NYSE:UAA), Skechers (NYSE:SKX), and Lululemon (NASDAQ:LULU) are all below $6 billion in annual sales, and they are growing revenues at low single- to double-digit paces.
So, considering Nike is nearly seven times the size of those companies, growing revenues at a comparable high single-digit to low double-digit rate is impressive — so much so that investors shouldn’t be concerned about revenue expansion slowing from a 14% clip in the second quarter. That sort of growth was unsustainable. Now, it’s normalizing down to a much more-sustainable but still very healthy high single-digit rate.
Further, gross margins expanded 130 basis points in the quarter. That’s actually better than last quarter’s expansion rate of 80 bps. Next quarter, those margins are expected to move higher again. Same for fiscal 2020.
Overall, then, Nike is still firing on all cylinders. Growth slowed sequentially, but this remains a high single-digit revenue grower with healthy gross margin drivers. That profile is good enough to keep NKE stock on a medium- to long-term uptrend.
Nike Stock Remains A Winner
In the big picture, double-digit revenue growth and strong margin expansion in the third quarter underscore Nike’s long-term bull thesis.
That bull thesis is simple: The athletic apparel world is growing fast thanks to certain secular trends –such as the convergence of athletic and casual styles against the backdrop of a consumer who has become focused on health, wellness, and fitness. This trend won’t reverse course anytime soon. Consumers are only becoming more obsessed than ever with health, wellness, and fitness, and as such, are growing increasingly fond of athleisure styles. Net result? The athletic apparel space will keep growing at a healthy rate over the next several years.
Dominating the athletic apparel space is Nike. After falling asleep at the wheel in the mid-2010’s, allowing competitors to gained, the sleeping giant woke up in 2017. It’s been firing on all cylinders ever since, leveraging product innovation, a direct sales strategy, and edgy marketing to gain a sustainable lead over rivals. As such, while the athletic apparel space continues to grow over the next several years, Nike projects as an above-average grower in that space, with margin upside thanks to a pivot to direct sales.
In numbers, that long-term bull thesis translates into sustained mid to high single-digit revenue growth potential over the next several years, alongside gross margin expansion and potential opex leverage as direct investments wind down. Modeling that out, that makes $5.30 in earnings per NKE share seem doable by fiscal 2025.
Based on a historically average 25x forward multiple, that equates to a fiscal 2024 price target for Nike stock of more than $130. Discounted back by 9% per year (a point below my normal 10% discount rate to account for the yield), that results in a fiscal 2019 price target of over $85.
We are now only one quarter away from the end of fiscal 2019. As such, as Nike stock closes in on $80 during this sell-off, a “buy the dip” thesis starts to look pretty compelling.
Bottom Line on NKE Stock
Despite the ugly stock price reaction, Nike’s Q3 earnings report wasn’t that bad. If anything, it was really good, just less good than the Q2 results.
Nike stock will sell off here as investors digest the new slowing growth trajectory. But, the sell-off won’t be that severe because NKE stock wasn’t overvalued, and the numbers are still pretty good. As such, the dust should settle soon, and when it does, that will be an opportunity to buy the shares at a relative discount.
As of this writing, Luke Lango was long NKE, SKX, and LULU.
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