Investors in Nike (NYSE:NKE) have not experienced a great start to 2014. That's because shares in the sports apparel company are down 7% while the S&P 500 is flat. However, Nike could have the potential to deliver gains for the year and prove itself to be a hot stock. Here's why.
With the Federal Reserve commencing the tapering of its monthly asset repurchase program, it signals the beginning of the end for the super-loose monetary policy that has been a feature of the US economy over the last few years. Although at least a year away according to new Federal Reserve Chair, Janet Yellen, interest rate rises could allow investors to 'find out who's swimming naked', since they will mean increased borrowing costs for indebted companies. This means reduced margins (unless higher borrowing costs can be passed onto consumers who, incidentally, could also have higher interest costs) and, ultimately, a squeeze on profits.
On this front, Nike appears to be very well-positioned. Its debt to equity ratio stands at just 12%, which means that for every $1 of net assets on Nike's balance sheet, it has just 12 cents of debt. This is very low and shows that Nike is on a firm financial footing for medium to long-term growth because interest rate rises are unlikely to affect it too much, simply because it has very little debt. It could even mean improved profitability relative to competitors, since they may have more debt and find their expenses rise at a faster rate than Nike's (due to interest rate rises) in future.
A Disappointing (But Understandable) Yield
With interest rates being so low, dividend yields have become a greater focus for investors. That's understandable, since savings accounts are paying such small amounts, so people are turning to shares for a higher income. On this front, Nike disappoints somewhat, since its dividend yield is just 1.3%. That's considerably lower than the yield on the S&P 500 (which yields around 2%) and the explanation appears to be two-fold.
Firstly, Nike is mean when it comes to paying out profits as a dividend. For instance, it pays out just 31% of profits as a dividend which, for a relatively mature company such as Nike (in an industry which, let's face it, is about as mature as it gets) is pretty mean. Nike could afford to pay out a much higher proportion of profits as a dividend, although this would have to be balanced with ensuring there is enough capital reinvested in the business for expansion, too.
Secondly, Nike's current valuation is rather high. For example, it currently trades on a price to earnings ratio (P/E) of 24.9 (trailing 12 months), which is a lot higher than that of the S&P 500, which has a P/E ratio of 17.7. This combination of a mean dividend payout ratio and a relatively high valuation work to produce a yield of just 1.3%.
Top Growth Prospects Over The Next Year
The reason for the higher P/E seems clear: growth prospects. Nike's year-end is May and between May 2014 and May 2015 the company is forecast to increase earnings per share (EPS) by just under 14%. This is considerably higher than the expected growth rate of the S&P 500 and makes Nike's valuation seem a lot more reasonable (and translates into a price to earnings growth rate (PEG) of 1.9). It could even be said that Nike's current valuation is well-worth it, when the growth prospects and financial standing of the business are taken into account.
A Look At Nike's Competitors
Of course, Nike isn't the only sportswear brand out there. Sector peers Under Armour (NYSE:UA) and Adidas (NASDAQOTH:ADDYY) also appear to be relatively attractive at current levels. In Under Armour's case, it offers investors a very high forecast growth rate in EPS, with the bottom line expected to increase by 23.3% in 2014. This is much higher than that of Nike (and several times higher than that of the S&P 500), which highlights just how strong the growth prospects for Under Armour really are.
However, Nike beats its rival in terms of valuation, with Under Armour currently trading on a trailing P/E of 69.6 (far higher than Nike's 24.9), although the gap narrows somewhat when Under Armour's growth potential is taken into account, with it having a PEG of 2.4 versus Nike's PEG of 1.9.
Meanwhile, Adidas continues to offer a potent mix of growth and value. Shares currently trade on a trailing price to earnings ratio of 21.9 (the lowest of the three stocks) and yet offer super growth prospects, with EPS forecast to increase by 18.9% in 2014 alone. This is higher than Nike's forecast growth rate in EPS and, in addition, shares in Adidas trade on a lower P/E than Nike. This, though, shouldn't make Nike appear unattractive, but rather highlight the potential across the sports apparel sector after a mixed start to 2014.
Furthermore, Adidas and Under Armour also offer low debt to equity ratios of 25% and 15% respectively. Although both figures are higher than that of Nike, all three companies appear to have sound balance sheets that should help to provide stability when interest rates do rise.
Overall: Nike Could Be A Hot Stock For 2014
Although it's had a tough start to 2014 (and the news on Tiger Woods is yet another blow, I admit) Nike could still pull out a strong performance over the medium term. The company comes with strong growth prospects, a balance sheet with very low debt levels and it also has the potential to pay a far higher dividend than at present. All of this combines to make Nike a hot stock with a bright future.
Robert Stephens has no position in any stocks mentioned. The Motley Fool recommends Nike. The Motley Fool owns shares of Nike. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.