Shares of athletic apparel giant Nike Inc (NYSE:NKE) are on investors’ radars. On the heels of the Cleveland Cavaliers’ remarkable comeback to win the NBA championship and ahead of the 2016 Summer Olympics, this is an exciting time to be an owner of NKE stock.
NKE stock took a bit of a tumble Friday, as the Brexit sent shares lower globally. Add to volatility from Nike’s generally disappointing earnings report released on Tuesday, and there’s bound to be a lot of uncertainty around the company for the time being.
In fact, shares have already dropped 20% from its December 52-week high at $68. This leads us to an obvious question: Is Nike a buy now? Here are three pros and three cons to NKE stock.
NKE Stock Pros
Impressive Growth Target: Nike management is targeting a rather ambitious $50 billion revenue target by the year 2020. The company did $32 billion in the most recent trailing 12 months.
To achieve this $50 billion target, the company needs a roughly 12% annualized growth rate between now and then. Given the company’s current price-to-earnings ratio, a 12% growth rate (assuming flat margins) leaves the business at a price/earnings-to-growth ratio of 2, a fine level for a powerful brand with strong margins.
Nike has annualized 12% growth over the last five years and 10% growth over the last ten years. So, the target is within range, though perhaps a bit on the ambitious side. If they can do it, NKE stock is probably undervalued by a decent degree. The key for achieving the target will be watching how sales in China go, as Nike has made a big play on that market.
NBA Championship: The Cleveland Cavaliers made one of the most impressive comebacks in the NBA finals history to pull off a historic upset over the heavily-favored Golden State squad. Trailing 3 to 1 in the series, LeBron James led the Cavs back, winning three straight games including the dramatic finale.
This is good news because other than Michael Jordan, James is the next most important face of Nike’s basketball franchise. And archrival Under Armour Inc (NYSE:UA) spokesman Steph Curry failed to meet high expectations in the final few games.
To the extent that the finals were a Nike versus Under Armour clash, Nike got the better end of it. On top of James’ obvious success, key young star Kyrie Irving made numerous key plays for the Cavs down the stretch.
Nike could hardly have asked for a better result than two of their top basketball endorsers engaging in key heroics in a memorable championship series. The chatter that Under Armour is taking Nike’s crown should die down at least a bit.
Not Too Exposed to the Brexit: With the uncertainty surrounding the Brexit, many U.S. multinationals took a big hit last Friday. Fortunately for NKE stock, the company is not that exposed to the country’s market. Nike only generates $1.1 billion a year of revenue from the U.K., and people hadn’t been counting on any growth in the U.K. next year as part of the path to $50 billion by 2020.
An analyst from Macquarie suggested that Nike could take an earnings hit between 2 and 3 cents per share, depending on how far the British Pound falls. For a company that earns more than $2 per share, this is not a significant blow.
Of course, there could be more impact if Europe continues to slump from the Brexit decision. However, the company is mainly reliant on the U.S. and emerging markets such as China. In general, the Brexit is not a big risk factor here.
Nike Stock Cons
Olympics Unlikely to Boost NKE Stock: As we approach the Summer Olympics, there will certainly be people interested in buying NKE stock. However, it is not that simple. Yes, Nike will be in the news and their logo will get a great deal of attention. But it doesn’t mean that shares have to go higher in the near-term.
According to Wells Fargo Analyst Tom Nikic: “[O]ver the past 10 years, the stock has declined on 75% of the earnings releases that immediately preceded a major sporting event, and the other 25% of the time it had yet to recover from the prior competition.”
Specifically, ahead of the last two Olympics, Nike shares fell between 9% and 10% on each occasion. The stock also has a tendency to drop ahead of World Cups. Like Walt Disney Co (NYSE:DIS) stock recently dropping after the release of the highly awaited Star Wars movie, oftentimes the event is already more than priced into the stock.
Nike Stock Is Still Expensive: The recent selloff has done a good job of bringing NKE stock down from the stratosphere. But don’t mistake cheaper for cheap. The P/E ratio has fallen back to 25 with the recent selloff, and that’s admittedly a big improvement from the ratio of 32 that it reached recently.
However, NKE stock has historically traded at a sub-20 P/E ratio; between 2001 and 2011, it spent the vast majority of the time quoted with a P/E ratio between 15 and 20. Further P/E ratio compression from the current price back to 20 — the top end of the range — would leave the stock in the mid-40s.
Furthermore, there’s not a lot of support for NKE stock from the dividend. The company does pay a dividend, and it has raised that dividend every year since 2009. However, NKE stock still yields only 1.2%.
The dividend has been raised at an admirable 15% annual clip over the last five years; however, at this level of yield, it’s still not going to attract much interest from income-seeking investors. The company’s main capital return strategy has been through share buybacks.
Those help investors in the long haul; however, given the level of overvaluation in NKE stock recently, it paid a dear price for recently repurchased shares. A larger dividend would likely have done more to support the share price.
Potential Weakness Next Couple Quarters: Morgan Stanley recently downgraded NKE stock and cut their price target. They cited several retail chain store bankruptcies as a negative factor that has caused inventory to pile up. When you combine this with a strong push toward lower-margin online sales, the firm sees potentially soft results later this year.
Add to that the rise in the U.S. dollar, and the company will probably endure another setback due to changes in foreign exchange. Tuesday’s earnings report cited foreign exchange weakness as one of the reasons for the soft results, and that quarter ended before this latest drop in the value of foreign currencies. The tumbles in the value of the Pound and Euro following the Brexit will hurt margins from those geographies. Additionally, the Chinese Yuan has fallen to fresh 5-year lows against the dollar.
Bottom Line for NKE
The time is approaching for new purchases of NKE stock. But we’re not quite there yet.
Both the ongoing Brexit drama and possible volatility from Tuesday’s lackluster earnings report could drop the stock further in the short-run. And historically, Nike shares haven’t done well in the run-up to major international sporting events.
As of this writing, Ian Bezek did not hold a position in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
