"Fiscal 2013 was a great year for Nike (NKE 0.66%), driven by our innovative products and the power of our brands," said Nike CEO Mark Parker in the company's fourth-quarter and full-year earnings release. But don't let his optimism fool you. Management will need to step up their game if they want to live up to investors' expectations for Nike stock.
Good, but not good enough
For the 12 months ending May 31, Nike's EPS from continuing operations were up 11%. Going forward, analysts (on average) expect EPS to grow by about 11.4% per annum. All of this sounds terrific, right? Not when we take into consideration Nike's premium valuation at 25 times earnings.
Let's do the math.
First, let's identify long-term growth rates that could help us establish Nike's growth trajectory as a business. The company's five-year average EPS growth rate is 10%. What about its free cash flow (arguably a better measure of underlying value)? A five-year compound growth rate stands at just 6.3%. Finally, there are those bullish estimates from the analysts covering Nike stock, with expectations for 11.4% EPS growth per annum for the next five years.
Given these historical growth rates, combined with analysts' bullish estimates, I'd say that estimating Nike's free cash flow to grow on a 10-year trajectory that looked like this would be optimistic:
|
Year |
Growth Rate |
|---|---|
|
1 |
11.4% |
|
2 |
10.8% |
|
3 |
10.3% |
|
4 |
9.8% |
|
5 |
9.3% |
|
6 |
8.8% |
|
7 |
8.4% |
|
8 |
8% |
|
9 |
7.6% |
|
10 |
7.2% |
Based on a discounted cash flow valuation using these assumed growth rates and a 10% discount rate, the fair value of Nike stock is about $58.
That's a problem. Nike shares are trading above $58, around $62.
Nike would need to perform even better than these optimistic estimates in order for us to earn 10% per year (equal to the discount rate) or more.
What am I missing?
Is there a growth opportunity I overlooked? Could emerging markets be the magic variable?
Nike's emerging markets revenue was up 16% in fiscal 2013 from last year. That's great, but the division unfortunately accounted for only 14.6% of Nike's 2012 revenues. And adding another weak point, once currency changes are taken into account -- the division's revenues were up only 9% in 2012.
What about China? Nike's Greater China segment isn't looking so hot. Revenue in the trailing 12 months was down 3%, including currency changes, from the year before.
Japan? The picture's even worse.
Even if we did identify a growth opportunity, it's going to have to be pretty significant to justify the company's current valuation. I don't want to buy Nike even at fair value; a margin of safety of at least 10% would be nice. At today's price, Nike shares aren't even close to a bargain.
Competition
Though Nike does boast impressive gross margins compared to its footwear competitors, three of them, Adidas, Puma, and Under Armour (UAA), are large enough to cause some disruption in some of Nike's markets.
Under Armour, in particular, is on fire, with a three-year average revenue growth rate of 29%. The company is still growing with strong momentum. In its most recent quarterly results, the company raised its full-year outlook, estimating 23% to 24% revenue growth as opposed to a previous estimate of 21% to 22%. With revenue at about 8% of Nike's, Under Armour is getting large enough to put a dent in Nike's armor.
Price matters
Nike may be a great business, but high expectations seem to have taken the price too far. Does this mean it's time to sell Nike shares? Not necessarily. The business is still doing excellent. Plus, my estimates could be too conservative. But Nike stock is looking a bit pricey to buy at $62.
