The question when it comes to Nike (NYSE:NKE) is valuation. There’s little argument that Nike’s business is attractive, the concern is the price of NKE stock.
And price does matter here. In 2015, the earnings multiple assigned to Nike stock reached the mid-20s. NKE spent the next two years trading basically flat before rallying in 2018. At a current price of $77, investors again are paying about 25 times forward earnings.
That seems too dear a price, even for this business. I made a similar argument about six months ago — and, since then, Nike stock basically is flat. That’s not a bad performance, actually — broad markets are down over that stretch — but it leaves NKE stock in a similar position to where it stood in July, and in late 2015.
Again, the business is attractive. But if the stock is going to rise from here, outside factors will need to cooperate as well. And, in this market, I’m not sure I expect that outside help — or believe that NKE is the play if it comes.
Footwear Still Drives Nike Stock
When NKE neared its lows late last year, one big issue was that demand in the footwear category seemed to be slowing. In the first quarter of fiscal year 2018 (the three months ending August 31, 2017), for instance, total Nike revenue actually was flat year over year. U.S. sales declined.
And that wasn’t just a Nike problem.
Rather, it seemed like the demand for high-end sneakers, in particular (a hot trend for years), was starting to fade. Weakness at Under Armour (NYSE:UA,UAA) and even adidas AG (OTCMKTS:ADDYY) showed that Nike wasn’t alone in seeing revenue growth slow.
Since then, results have improved essentially every single quarter, including a strong Q2 FY19 report. Easy comparisons have helped somewhat the last two quarters — but Nike’s execution gets some of the credit as well.
That said, so does the category. Results from rivals show that footwear demand overall has rebounded. The same is true of customers. Foot Locker (NYSE:FL) has posted better numbers and so have other retailers like Shoe Carnival (NASDAQ:SCVL) and DSW (NYSE:DSW).
The sneaker trend seems to be back. The question for NKE stock is what happens if and when it fades again. As we saw last year, even a market leader can’t drive growth if the category on the whole slows down. And either fashion changes or a weakening economy could again lead footwear demand to slow. That almost certainly would be bad news for NKE.
The China Story for NKE Stock
Nike needs some help from the Chinese economy as well. Nike’s performance in China is becoming a larger part of the story behind NKE stock. Revenue in Greater China rose 31% on a constant-currency basis in Q2, accelerating from 20% growth in Q1. The market has driven over 15% of total Nike sales in the first half — and is responsible for over one-third of this year’s total revenue growth.
Does that strength hold? The rising popularity of basketball in China and the growing middle class both suggest the market could be enormous for Nike, with years of growth ahead. But there also are at least near-term concerns about the impact of the trade war and an apparently slowing Chinese economy.
We’ve seen both Starbucks (NASDAQ:SBUX) and particularly Apple (NASDAQ:AAPL) get dinged by exposure to that market. There’s a risk for Nike, too. Second-half growth, as comparisons get tougher, is going to depend at least in part on strong results from China. If the trade war has any effect, that could color even the long-term story for NKE.
Better Options Elsewhere?
None of this is to suggest that Nike stock is a short — or even necessarily a sell. But the stock does need at least some cooperation from external factors — at a time when investors are notably more worried about those factors.
And where the case for NKE weakens is in the idea that there are better investment opportunities out there beyond paying mid-20s earnings multiples for NKE. There’s no shortage of cheaper plays on China growth, both direct in-country providers and stocks like AAPL.
A macro downturn would hit Nike stock hard: the stock slipped 20% just between early October and mid-December on basically no news. I’d rather take that cyclical risk with stocks that haven’t yet recovered to the same extent (here, too, there are myriad options, particularly in semiconductors and housing).
Has Nike peaked? Probably not. Is NKE stock going to rise longer-term? Probably; it’s been a hugely impressive investment over time. But it’s tough to make a compelling case for paying 25x next year’s earnings for a stock that does have some external risks.
Investors willing to take those risks can find much cheaper options elsewhere. Even if those risks don’t materialize, and NKE stock rises, it seems like other stocks could, and will, do much, much better.
As of this writing, Vince Martin has no positions in any securities mentioned.