Nike (NYSE:NKE) posted lukewarm results for the quarter ending Feb. 28 with sales up just 5% year-over-year (YOY). It’s likely this quarter ending May 31 could show even worse results. We won’t know until late June or early July. The problem is investors in NKE stock likely won’t wait — they will sell first and ask questions later.
The smell of a coming recession and bear market is in the air. Investors will likely sell NKE stock now and buy back later if future news is better than expected.
Here is one reason why this could be the case. Nike produced flat free cash flow (FCF) during its fiscal third quarter. It made just $169 million in cash flow from operations (CFFO), and after $154 million in capital expenditures, that comes out to just $15 million in FCF.
This is very unusual because in the prior quarter, Nike produced $2.579 billion in FCF. Moreover, a year earlier, it generated $1.113 billion in FCF. In other words, the flat results in the February quarter were not seasonal in nature.
What really happened is that demand is falling. This showed up in its cash flow statement with a dramatically higher inventory. Its inventory balance shot up by $1.14 billion from $6.5 billion at the end of November 2021 to $7.7 billion in Q3. That’s because the inventory they bought isn’t selling on time.
It’s always a really bad sign when a retailer has an unexpectedly large increase in its inventory, especially if it is nowhere near Christmas time. The market sees this, and NKE stock has been falling as a result.
Since March 21, when the Q3 results came out, NKE stock has fallen from $130.19 to $114.49 as of May 6. It is likely to fall further, especially if the market believes that the excess inventory is a sign of falling demand for Nike products.
For example, the company may have to discount its prices very heavily just to get rid of this excess inventory. That will hurt its sales and profitability going forward. Moreover, if the company thinks the problem is temporary and keeps overspending on inventory, its cash flow will turn negative. The market will realize this and discount NKE stock very heavily when its next quarterly results come out in late June.
Either way, investors should probably be very careful with NKE stock going forward. Its cash flow issues are likely a problem relating to slower consumer demand. Given that it sells on a high forward price-to-earnings (P/E) multiple of 25 times, investors will want to wait until the stock gets cheaper.
On the date of publication, Mark R. Hake did not hold any position (either directly or indirectly) in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.