Nike Stock Looks Compelling on This Recent Selloff

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NKE stock - Nike Stock Looks Compelling on This Recent Selloff

Source: Alessio Jacona via Flickr

For nearly a year, sports apparel giant Nike (NYSE:NKE) was on a seemingly unstoppable tear. From late 2017 through October, the just-do-it shoemaker successfully fought off the Adidas (OTCMKTS:ADDYY) threat. It was again growing its North America business, accelerating product innovation at unprecedented levels, and had quickly become the hottest brand again. All this while maintaining a star-studded athlete portfolio and robust financials.

But, absent anything that the company has done, NKE stock has been thrown off its winning trajectory over the past two months. During that stretch, the shares have lost more than 12% on concerns that a global economic slowdown will upend Nike’s recent operational momentum. The S&P 500 index is down 8.6% in the same period.

I don’t see that momentum bust happening any time soon. While global economic fundamentals are getting softer, they are broadly still positive. Meanwhile, this recent drop has brought the valuation on NKE stock to levels which are pretty attractive considering the brand’s recent operational strength.

Net net, I think NKE stock looks good on this sell-off. If the numbers over the next several quarters look pretty good, the shares will easily take back all the ground lost over the past two months, and then some, making this recent sell-off look more like an opportunity than anything else.

Nike’s Brand Has Plenty of Momentum

To be sure, Nike was getting its butt kicked by Adidas as recently as a year ago. Then, management leveraged a streamlined sales strategy into 2018 — alongside enhanced product innovation — to once again create momentum throughout the entire business.

The numbers are solid and improving. Nike’s brand revenues grew 10% year-over-year last quarter, better than the prior quarter (+9%) and the quarter before that (+4%). Importantly, the North America business has turned things around, posting back-to-back quarters of positive growth after a multi-quarter streak of negative growth. Also, gross margins rose last quarter, ending a streak of gross margin declines, and profit growth accelerated to 15%, versus profit declines in the year-ago quarter.

At the same time, the trends are also solid and improving. Foot Locker (NYSE:FL), which sells mostly Nike product, just reported strong quarterly numbers and highlighted Nike as a growth segment on the earnings call. Both domestic and global search interest trends for Nike are moving higher. The early read on Black Friday sales is strong, especially on the digital front, where Nike has doubled down over the past year. Among trend-oriented teens, Nike remains the number one clothing brand, the number one footwear brand, and the number two shopping website, according to Piper Jaffray.

There’s a lot to like about Nike here and now. All signs point to this brand having a ton of momentum ahead of what it shaping up to be a strong holiday season.

Looming Tariffs Shadow

The only thing not to like about NKE stock is the fact that tariffs and rising rates threaten the currently red-hot economy. These threats are legitimate. Unless the Fed pauses on its rate hike agenda and/or President Trump resolves things with China, economic growth and consumer confidence will drag lower over the next several months.

But, that doesn’t mean we are heading for a recession. Growth isn’t too hot (GDP has followed a nice trend since World War II, we are well below that trend currently due to a slow recovery from a big 2008 wipe-out, and every recession in recent memory has been preceded by above-trend growth). Debt levels remain checked (net corporate debt to GDP is well off record highs, and simply in line with its long-term average). The 10-2 Treasury Yield spread, which has inverted prior to every recession in recent memory, remains in positive territory. Inflation is contained. Unemployment is low. Wages are rising.

Overall, we aren’t heading for another recession in the near future. Instead, we are just heading for a slowdown. A slowdown won’t upend Nike’s recent momentum, and as such, the current valuation on NKE stock looks attractive.

Brand Tailwinds Cancel Economic Headwinds

The growth fundamentals underlying Nike are very good right now, but are challenged somewhat by a slowing economic backdrop. Nonetheless, this is a company which should, at the very least, maintain its historical growth rates as brand momentum tailwinds and slowing economic expansion headwinds cancel each other out.

Over the past five years, Nike has grown revenues at a 7.5% annual clip. That rate seems very achievable over the next 5 years. Assuming so, that would put revenues in fiscal 2023 at roughly $52 billion. Gross margins are off their highs but bouncing back to 45% with renewed sales momentum, and opex rates are fairly stable around 30-32%. Assuming those to be stable long term, you are talking about potentially 15% operating margins in five years, or about $7.8 billion in operating profits. Taking out 20% of taxes, that leaves you with $6.2 billion in net profits.

Ignoring buybacks and simply throwing a historically average 25 forward multiple on that, you get to a four-year forward valuation on NKE stock of roughly $156 billion. The market cap today is $110 billion. So, you are talking about 9% annualized return plus a 1% dividend yield and 4%-plus buyback yield. All together, that makes for a pretty good long-term return profile for NKE stock from current levels.

Bottom Line on NKE Stock

NKE stock is a long-term winner that got over-extended in the near-term. The stock has now corrected downwards to more reasonable valuation levels without much changing regarding the fundamentals. That means this dip is an opportunity.

As of this writing, Luke Lango was long NKE and FL. 


Article printed from InvestorPlace Media, https://investorplace.com/2018/11/nike-stock-looks-compelling-on-this-recent-sell-off/.

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