Will Technology Acquisitions Power Nike Inc Stock Higher?
Over the past several years, I have closely followed the whole athletic retail competition between Nike Inc (NYSE:NKE), ADIDAS AG/S ADR (OTCMKTS:ADDYY), Under Armour Inc (NYSE:UAA), Skechers USA Inc (NYSE:SKX), and Lululemon Athletica inc. (NASDAQ:LULU).
While the story has changed dramatically over time, this is the current landscape in a nutshell: Nike is making a massive comeback, Adidas remains red hot, Under Armour is losing market share, Skechers is gaining market share, and Lululemon continues to be the most in-demand athletic apparel choice for women. Naturally, one would think the smart trades are long Nike stock, Adidas stock, Skechers stock and Lululemon stock, and short Under Armour stock.
But it isn’t so simple. Especially when it comes to Nike stock.
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Nike is making a massive comeback. There is no doubt about it. North American sales, which have been under pressure for the past several quarters, are nearing a critical inflection point. The volume of innovation in the company’s product pipeline is as robust as it’s ever been. The brand continues to add high-profile endorsers at an impressive clip. And management just shuffled out a fair amount of money to accelerate the company’s digital transformation through two critical technology acquisitions.
And yet, despite those positives, I don’t think Nike stock is a screaming buy at these levels. Here’s why:
Nike Stock Has Already Had Its Run
The big problem with NKE is that this stock has already had its run in anticipation of this operational resurgence. Over the past six months, Nike stock is up 30%. The S&P 500 is up just 4% in that same timeframe.
Now, Nike stock trades at nearly 26-times forward earnings. The five-year average forward earnings multiple is 24. In other words, the stock already seems priced for perfection.
Granted, perfection might happen. The company has been going full speed with its Consumer Direct Offense initiative, which is the company’s attempt to modernize and streamline everything about the business. Most recently, Nike acquired two technology companies in a month.
The first, a data analytics firm, will be used to leverage consumer data from direct selling channels to optimize product creation around consumer preferences. The second, a computer vision firm, will be used to modernize the Nike in-store experience so that consumers can be scanned by a computer and directed to best-fitting clothes in the store.
Those are pretty smart acquisitions. They not only make Nike smarter, but they also enhance the company’s product creation ability and improve the brand’s overall image.
Moreover, Nike’s newest styles are resonating well with consumers. Search-interest related to Nike’s newest shoe technologies has grown significantly over the past 12 months. Plus, Nike’s newest headline NBA athlete, rising superstar Giannis Antetokounmpo, is set to release a signature shoe by the end of 2018.
Nike Stock Is Fully Valued
All together, perfection really isn’t that unlikely for Nike over the next several years. All the piece are coming together at the right time. But even with perfection, Nike stock looks nearly fully valued at current levels.
At best, Nike can grow revenues around 7.5% per year over the next five years from this year’s projected $36 billion base. That is roughly in-line with the trailing five-year growth rate of 8%. But it is slightly less to account for increasing scale.
Operating margins, which are currently under pressure and hovering around 12%, could zoom to as high as 15%. Margin improvements will be driven by an improving brand image, which could provide a lift to average sales prices. Margin expansion will also be driven by streamlined investment.
Under best-case scenario modeling of 7.5% revenue growth and 15% operating margins, revenues and operating profits would be $51.7 billion and $7.8 billion, respectively, in five years. Taking out 13% for taxes and dividing by a presumably reduced share count of 1.6 billion, that equates to roughly $4.22 in earnings per share in five years.
A historically average 24-times forward earnings multiple on those $4.22 earnings implies a four-year forward price target of roughly $101. Discounting back by 10% per year, you arrive at a fair value of about $69.
Bottom Line on NKE Stock
The company is doing everything right to reignite growth and once again dominate the athletic retail market. But Nike stock has already run up in anticipation of this renewed growth.
At current levels, there isn’t much upside left to fair value, even in a best-case scenario. Thus, I’m not a buyer here. But I am a buyer on any material weakness to the lower $60s.
As of this writing, Luke Lango was long SKX.
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