Nike Is Facing Challenges

Nike Inc. (NYSE:NKE) is the largest footwear and athletic apparel company in the U.S. with approximately $49 billion in global revenue.

Under the Nike Jumpman trademark, the company provides athletic and casual footwear, apparel and accessories. It also sells shoes and clothing under the Converse, Chuck Taylor, All Star, One Star, Star Chevron and Jack Purcell brands. In addition, Nike offers sporting equipment and accessories such as bags, balls, eyewear, bats, gloves and other protective equipment.


The company sells its goods through a variety of channels and outlets, including footwear stores, sporting goods stores, athletic specialty stores, department stores and its own branded Nike stores. It is found at the top of the list of the world's more recognizable and value brands.

Founded as Blue Ribbon Sports in 1964, the company changed its name to Nike in 1971. It currently has a market capitalization of $143 billion.

Financial review

In late September, Nike reported its fiscal first-quarter 2023 results for the period ended Aug. 31.

Revenue increased 10% on a constant currency basis, with strength in direct sales at 14% constant currency growth. Nike brand digital sales increased 23%. Gross margins decreased 2.2% to 44.3% as has been common in corporate America recently, in this case due to elevated freight and logistics costs. Diluted earnings per share for the quarter were 93 cents, down 20% from the prior-year period.

Nike Is Facing Challenges
Nike Is Facing Challenges

One of the stunning notes in the release was the comment on inventories, which increased 44% to $9.7 billion. This was driven by elevated in-transit inventories from ongoing supply chain volatility.

Cash and equivalents and short-term investments were $11.9 billion, which decreased approximately $1.8 billion from last year as free cash flow was offset by stock repurchases and payment of cash dividends. Total debt was $9.4 billion and operating lease liabilities were $2.7 billion.

Nike Is Facing Challenges
Nike Is Facing Challenges

The company generates significant amounts of free cash flow most years, ranging from $4 billion to $6 billion. Dividend payments totaled $480 million and share repurchases totaled $1 billion for the quarter. However, buying back that many shares with the company's elevated valuation levels may not be the best use of corporate capital.

Valuation

Consensus analyst earnings per share estimates are $2.98 for the fiscal year ending May 2023 and $3.78 for the following year. Giving it the benefit of using next year's more normalized earnings, Nike's stock trades at 23 times forward-looking earnings. The forward enterprise value/Ebitda ratio is approximately 15. Management expects gross margins to decline between 2% and 2.50% in 2023.

The GuruFocus discounted cash flow calculator creates a value of $67, or roughly 30% below today's price. Inputs used were next year's earnings per share estimate of $3.78 and a 10% long-term growth rate.

The company pays an annualized dividend of $1.22, which creates a dividend yield of 1.35%.

Guru trades

Gurus who have purchased Nike stock recently include Ken Fisher (Trades, Portfolio), George Soros (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio), while Mario Gabelli (Trades, Portfolio) reduced his holding.

Conclusion

With one of the most recognizable logos in the world, Nike is truly a global company with a dedicated fan base. However, margins and continued growth are both facing headwinds. Sales to China, a critical component to overall growth, fell 13% last quarter. The excess inventory issue will continue to create operating margin headwinds for the foreseeable future.

The stocks excessively high valuation multiples do not create a margin of safety at this time when considering the multiple global and operating risks the company is facing. A lower entry point for investors is probably warranted, perhaps with a price-earnings ratio in the mid-teens range.

This article first appeared on GuruFocus.