Nike: Currently Unreasonably Valued

Investors need to pay particularly close attention to a company’s valuation to generate attractive long-term investor returns. In the case of NIKE Inc. (NKE), it appears shares are currently unreasonably valued.

I do not dispute NIKE is a high-quality company. If I had my doubts I would not have initiated a 500 share position on June 27, 2016, in one of the ‘Core’ accounts within the FFJ Portfolio.

My concern is the current valuation. When you acquire shares at NIKE’s current valuation, the probability diminishes that you will generate an attractive investment return.

Let’s have a very quick look at why I think shares are currently unreasonably valued.

Nike Business Overview

I am certain you know SOMETHING about NIKE. If you do not, however, I encourage you to read ‘Part 1. Business’ in the company’s FY2020 10-K. You should learn about the company’s Mission and NIKE’s FY2020 Impact Report and NIKE’s 2025 Targets. Learning as much about a company BEFORE investing hard-earned money is the very least an investor can do. Regrettably, too many investors skip this step. Perhaps this explains why NIKE’s shares are currently unreasonably valued.

Financial Review

Q3 and YTD2021 Results

NIKE released Q3 and YTD2021 results on March 18th. I encourage you to also look at the Financial Schedules and Key Metrics.

In March 2020, NIKE issued $6B of corporate bonds and secured a new $2B credit facility adding to the existing credit facility of $2B to ensure appropriate liquidity and flexibility during the COVID-19 pandemic. If you look at the FY2020 June 25, 2020, Earnings Release, management explains the increase in cash and equivalents and short-term investments is partially offset by share repurchase activity, cash dividends and investments in infrastructure.

We see from Note 7 – Short-Term Borrowings and Credit Lines and Note 8 – Long-Term on pages 75 and 76 of 110 in NIKE’s FY2020 10-K. Clearly, management is proactive! I get great comfort with my NIKE investment when I see this.

Free Cash Flow (FCF)

I look at various metrics but pay particularly close attention to the extent to which a company generates FCF. FCF provides management with options. They can deploy funds for the following purposes to enhance shareholder value:

• debt repayment;
• dividends;
• share repurchases.

Go to page 61 of 110 in NIKE’s FY2020 10-K. Take the cash provided by operations and deduct additions to property, plant and equipment. When you perform this exercise you see that in FY2018 – FY2020, NIKE generated ~$4B, ~$4.8B, and ~1.4B of FCF. Perform the same exercise for the FY2011 – FY2017 timeframe and you get ~$1B, ~$2B, ~$2B, ~$4B, ~$2B, and ~$3B.

As I compose this post, NIKE has not yet posted its Q3 10-Q and it did not include a Consolidated Statement of Cash Flows with its March 18, 2021 Earnings Release. Look at the Q2 10-Q for the period ending November 30, 2020, however, through the Securities and Exchange Commission EDGAR search tool. Within that quarterly report, you see $3.355B of cash provided by operations and $0.344B of additions to property, plant and equipment on the Unaudited Condensed Consolidated Statement of Cash Flows. That indicates NIKE has generated ~$3B of FCF in the first half of the fiscal year.

Financial Guidance

Management did not provide a specific earnings range for Q4 2021 on the Q3 Earnings Call. The company’s CFO, however, indicated:

‘Looking ahead to fiscal 22, we are already exceeding our pre-pandemic levels of business and I expect the momentum we are seeing will translate into continued, strong revenue growth. I will provide more specific guidance for fiscal 22 on our next earnings call.

As a growth company, our offence is working. Nike’s brand momentum is as strong as ever. Our product is resonating, the pipeline is strong, and our Brands are more deeply connected to consumers than ever before. The pace of our digital transformation is also accelerating, and we are investing against the large market opportunity we see. We are converting more consumers into members, and connecting more deeply, more frequently and more meaningfully via our digital platforms, and ultimately also through our One Nike Marketplace strategic partners.’

Risk Assessment

In the 3 decades in which I have been an equity investor, I have met several people whose investment experiences have been utter ‘train wrecks’. In just about every instance, a little time spent on assessing a company’s risk would have clearly indicated trouble lay ahead.

I have no intention of doing foolish things with our investments. This is why I check the ratings assigned by the major credit rating agencies when I analyze companies.

In the case of NIKE, I see Moody’s and S&P Global rate the company’s unsecured long-term debt A1 and AA-, respectively. Moody’s has assigned its rating since April 29, 2008, and S&P Global has assigned its rating since November 6, 2013. That is stability!

The A1 rating is the top tier of the upper-medium grade investment-grade category. This rating indicates an obligor has a STRONG capacity to meet its financial commitments. It is, however, somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

The AA- rating is one notch higher. It is the bottom tier of the high-grade investment-grade category. Such a rating indicates an obligor has a VERY STRONG capacity to meet its financial commitments. It differs from the highest-rated obligors only to a small degree.

The stability of these high-quality ratings meets my prudent investor profile.

Dividends and Dividend Yield

On November 19, 2020, NIKE announced that its Board of Directors had approved a $0.275/share quarterly cash dividend. This was a 12% increase versus the prior $0.245/share quarterly dividend.

The company’s website only reflects a dividend history dating back to fiscal 2007 but the November 19, 2020 announcement marked NIKE’s 19th consecutive year of increased dividend payouts.

The current $1.10 annual dividend only provides investors with a 0.8% dividend yield. This will likely dissuade investors seeking an attractive dividend yield. We each invest in equities to satisfy our personal goals and objectives, however, so it is not for me to question why investors would overlook high-quality companies just because the dividend yield is low.

I look at the complete package when investing in a company. I will gladly accept a sub 1% dividend yield if I think there is a very reasonable probability a company’s stock could end up being a multi-bagger. In fact, NIKE is one such investment!

On June 27, 2016, I initiated a 500 share position at an average cost of $52/share. Shares are now trading at ~$137.50.

I have also had success writing covered calls to generate additional income.

• February 4, 2019 – I wrote 5 April $87.50 contracts that generated $1.35/share (each option contract equals 100 shares).
• April 16, 2019 – I closed out those 5 contracts at $0.72/share.
• April 16, 2019 – I wrote 5 September $92.50 contracts that generated $3.14/share. These contracts expired worthless and I retained my shares and 100% of the option premium I had collected.
• February 3, 2021 – I wrote 5 March $155 contracts that generated $0.98/share. These contracts have just expired worthless and I still hold my shares and 100% of the option premium I had collected.

These option trades have generated $2375 in option premium income before nominal trade commission.

If I have a reasonable probability of generating capital gains and also have the opportunity to periodically generate some option income why would I care about a sub 1% dividend yield?

Stock Splits

NIKE’s stock splits do not add any value but they make the per-share price more affordable for some investors. I mention stock-splits so you do not get puzzled if you decide to review historical NIKE financial statements and see something strange with the annual EPS and share count values.

Share Repurchases

The weighted average number of issued and outstanding shares in FY2016 – FY2020 can be found in ‘ITEM 6. SELECTED FINANCIAL DATA’ on page 27 of 100 in NIKE’s 2020 10-K.

In the Q4 2020 Earnings Release, NIKE indicated it had repurchased 1.9 million shares for ~$0.159B before suspending share repurchase activity in March to maximize liquidity in what had become an extremely dynamic environment. As of May 31, 2020, a total of 45.2 million shares had been repurchased for ~$4.0B, resulting in ~$11B in remaining capacity under the 2018 share repurchase program.

On the March 18, 2021, Q3 Earnings Call, NIKE’s CFO indicated the company will resume moderate levels of share repurchase beginning in Q4.

Valuation

NIKE’s present valuation is currently my concern.

In the first 9 months of the current fiscal year, NIKE has generated $2.62 in diluted EPS. On the Q3 call with analysts, management also indicated the company is already exceeding pre-pandemic levels of business.

Management did not provide guidance for the year so I am extrapolating YTD EPS and am adding a few extra pennies per share since management says the company is exceeding pre-pandemic levels of business. If NIKE generates ~$0.91 – ~$0.93 in Q4 EPS we get FY2021 diluted EPS of ~$3.53 – ~$3.55. Using the current ~$137.50 share price we get a forward diluted PE of ~39.

As noted earlier, I acquired 500 shares @ ~$52 on June 27, 2016. At the time, NIKE had reported $2.16 diluted EPS for the 12 months ending May 31, 2016. The PE when I acquired shares was ~24. Now, the PE is ~39! NIKE might be a great company but you do not generate decent returns when you acquire shares at the current valuation.

During the FY2011 – FY2020 timeframe, NIKE’s PE has been 20.64, 21.86, 26.75, 28.62, 30.34, 22.39, 27.08, 55.74, 35.42, and 79.93. NIKE is wonderful with a nice runway ahead of it so I am prepared to pay up a bit to acquire additional shares. A PE in the 26 – 27 area seems reasonable to me but not ~39!

If NIKE generates $3.55 in EPS for the current fiscal year and we use a 27 PE then a price under ~$96 is the level at which I would acquire additional shares.

Conclusion

There is no disputing NIKE’s dividend yield is low. Investors, however, are likely to disagree about NIKE’s valuation. In my opinion, achieving financial freedom becomes difficult when you are prepared to pay $39 for $1 of earnings.

You can certainly trade options to generate some income to improve your return on investment. The problem with this strategy, however, is you need to closely monitor your positions. If you have better things to do with your life than to frequently watch ticker symbols or if you are a ‘buy, hold, and forget’ investor, then options might not be for you.

There is absolutely no need to rush into NIKE. NIKE is not the only company in which to invest. Just be patient. Something will happen at some stage that will lead to NIKE’s valuation retracing to a reasonable level. I do not know when that will occur but when it does, THAT will be the time to gobble up NIKE shares.

Investors do crazy things when they disregard a company’s valuation. I’ve seen that movie before and it doesn’t end nicely.

Stay safe. Stay focused.

I wish you much success on your journey to financial freedom.

Thanks for reading.

Disclosure: I am long NKE.

Author Bio: I am a self-taught investor and run the Financial Freedom is a Journey blog. I have invested in the North American equities markets for over 33 years. I retired from a career in banking and continue to invest as this is something about which I am passionate.

Author Disclosure: I disclose our holdings which are held in the FFJ Portfolio and the dividend income generated from these holdings but for confidentiality reasons do not disclose details of holdings held in various tax-advantaged accounts.  

Author Disclaimer: I do not know your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. Consult your financial advisor about your specific situation.

Author Guest Posts: If you like this post and want to read more company analysis by Charles than check out this post on Canadian Pacific Railway

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