Nike: What’s Good, What’s Not? – Seeking Alpha

 In Business

Nike’s (NKE) long-term outlook remains very solid, whilst shares continue to trade at an inexpensive valuation. The company’s fourth quarter results reflect many strengths of Nike’s business model, although comparables were affected by one time items.

Over many years Nike has been a strong performer both regarding the company’s top line as well as its profits:

ChartNKE Revenue (NYSE:TTM) data by YChartsOver the last 10 years revenues doubled, while net income grew by 140% and EPS increased by an even better 190%, for an annual growth rate of 11.2%.

Nike’s top line growth was driven both by domestic growth in the US as well as the global expansion of the company’s presence, mainly in markets with a fast growing middle class population such as China.

This also was visible in the most recent quarter, where Nike’s highest growth rates were recorded in Greater China and the Emerging Markets group of countries (which recorded revenue growth rates of 11% and 21%, respectively). The high growth in these markets was enough to push the company’s total currency adjusted growth rate to seven percent year on year, despite the US market being flat (forex rates had a 200 base points negative impact, thus the GAAP revenue growth rates was lower at just 5%).

Nike also continued to deliver outsized earnings growth (EPS were up 22% yoy), although we have to look at that number more closely. The first factor that plays a role for Nike’s earnings growth (apart from top line growth) is the company’s gross margin, which, unfortunately, continued to decline:

ChartNKE Gross Profit Margin (TTM) data by YChartsNike has a declining gross margin since about one and a half years, and in the most recent quarter the company’s gross margin dropped by another 180 base points – Nike blames forex rates, but higher production costs had a negative impact as well. This is unfortunate, as a growing (or even flat) gross margin would allow for much better earnings growth, due to the impact of positive operating leverage – flat fixed costs would be distributed over an increasing gross profit number, thus lifting the company’s earnings by a wider amount.

Due to lower SG&A expenses Nike was able to grow its operating earnings by nine percent nevertheless, although the lower SG&A number was affected by one time items in the prior year, when Nike had spent a lot of money on advertising for the Olympics as well as for the Euro 2016 soccer tournament.

Nike’s net income was up by 19%, which is easily explained – the company’s tax rate dropped significantly year over year, coming in at below 14% in the most recent quarter. A tax rate that low seems unsustainable, I thus believe that investors should calculate with last year’s tax rate of 21% to get a number that better reflects Nike’s underlying performance. After all a 14% tax rate would still be low even if Trump manages to get corporate taxes down significantly. A 21% tax rate would have gotten us to net earnings of $922 million, still good enough for a nine percent growth rate year over year.

I thus conclude that Nike’s results were good mostly, but investors should not get dazzled by the high net income growth rate, since that growth rate is unsustainable due to the fact that it originated from a lower tax rate primarily.

ChartNKE Cash from Operations (TTM) data by YChartsNike’s business comes with relatively high operating cash flows, and cash needs are not very high – the company spends about one fourth of its operating cash flows on capex each year, which leaves about $3 billion in free cash flow for other purposes. Nike spends the biggest portion of that amount on stock buybacks historically, and continued to do so in the most recent quarter, where Nike repurchased shares for a total of $820 million.

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