Nike’s (NYSE: NKE) first-quarter results, which were released last week, prompted the stock price to finally break the $90 level where it had failed in April and July. The results were impressive across the board, and the technical setup looks very bullish. The valuation, however, looks very stretched.
Now that the price appears to be coming back for a retest of $90, it’s worth considering whether there is any way to justify a price above $90.
The results were good – but not as good as the headlines suggest
The financial media has been overwhelmingly bullish about Nike’s results. Indeed, first-quarter GAAP EPS of $0.86 were 15 cents ahead of consensus estimates, and 28.4% higher for the year. Quarterly revenue of $10.66 billion was $230 million ahead of estimates and 7% higher for the year.
The part that has been overlooked is how much of the earnings growth rate was driven by non-operating items (which swung from an expense to income) and the lower effective tax rate. When you exclude those from net income, growth drops from 25% to 15%.
There is nothing wrong with 15% earnings growth for a company with a $40 billion revenue run rate. But the investors need to treat the headline growth rate of 28% with caution and not see it as a long-term sustainable growth rate.
China is another part of the story that needs to be treated with some caution. China’s contribution to the top line did grow by an impressive 22% to $1.68 billion. This segment also contributes more to the bottom line due to its higher operating margin.
However, China’s contribution is still only 17% of total revenue. If current growth rates continue, it will take another 6 years for China to get to 50% of overall sales.
Lots to like about Nike
There are plenty of reasons to like Nike. It is one of the most valuable brands in the world, which gives it an impenetrable moat. It also has reliable and sustainable margins.
Nike is also managing to claw back market share from Adidas. It has a more stable revenue curve than Adidas which has seen year-on-year growth oscillating between 30% and zero.
Nike is also one of the most reliable earnings compounders outside of the tech sector, which counts for a lot.
How Much Is It Worth?
On a wide range of value metrics, Nike is trading at a 100% premium to its sector. By many of the same measures, it is the most expensive it been in the last 10 years and trading at a 20 to 30% premium to its own price history. Not only is the current price multiple of 34 high, but it may be understated compared to normalized earnings.
Some DCF models have a fair value of around $72. It is probably fair to give it a premium over that price given Nike’s high quality. Depending on that premium, a value of somewhere between $82 and $87 may well be justified. Above that range, long-term returns are likely to disappoint.
The time to make long term investments in a stock like Nike is after they have a bad quarter – not after a quarter when they shoot the lights out. That said, this a market favourite and there is every chance of another short-term rally if $90 holds.
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