Fool Plate Special: Nike's Q1 Layup

An Investment Opinion

Nike's Q1 Layup

By Brian Graney (TMF Panic)
September 17, 1999

Sneaker and athletic gear maker Nike (NYSE: NKE) took it to the hole in its fiscal first quarter, netting earnings of $0.70 per share compared to $0.56 per share last year. That dunked the First Call mean estimate of $0.65 per share, despite the fact that sales growth was a no-show during the quarter. What the firm lacked in revenue gains it made up for in operational efficiency as cost of sales fell 2% and selling, general, and administrative expenses dropped 4%. Throw in the effects of a lower tax rate and the cutbacks allowed Nike's net profit margin to expand to 8% from 6.5%.

After a worldwide slowdown fouled up its main business areas in late calendar 1997 and 1998, Nike is now staging a comeback. The company's evolving turnaround story has grabbed headlines over the past few quarters, but the business is still not quite up to its old speed. The firm may have managed to beat earnings estimates handily in its most recent quarter, but the Q1 results are still well below the $0.85 per share the company put up during the same period two years ago. While much will be made of the sustained earnings increases lately, long-term shareholders know that the secret to the company's success lies outside the income statement.

Calling Nike a lean manufacturer is a bit of a stretch, but it's done a commendable job of keeping the asset management ship upright throughout the latest storm. Over the past seven quarters, the company has managed to shed a fair amount of inventory, sending that account down 21% from the levels in Q3 of fiscal 1998. And while return on equity and return on capital dipped during the slowdown, the company was always able to keep its head above water and at least equal its cost of capital. Thus, Nike may have been value-neutral for a spell, but it never really relegated itself to the bush leagues of the value-destroyers. That trait alone enabled many shareholders to remain loyal fans even when the outlook was the most bleak.

Those loyal shareholders are now being rewarded as the company reverts to its value creating ways. Even though the firm's share price slipped a bit this morning, the stock has returned a market-beating 28.7% so far this year. A key intangible asset -- the firm's well-known and respected brand name -- remains strong. And a new crop of Nike TV ads, featuring the likes of basketball star Kevin Garnett and women's soccer heroine Brandi Chastain, are helping to keep the brand hip.

Looking ahead, Chairman and CEO Phil Knight sounds upbeat about the company's prospects. U.S. athletic footwear revenues were up 3% in Q1 and Knight is "encouraged" by early indications that strong spring results may be in store. U.S. future orders slipped 7% in the most recent period, but the company is not letting that statistic get it down. "We're certainly more optimistic than we were a year ago or even 90 days ago,'' Knight reportedly said during the company's post-earnings conference call.

Nike's attention should probably now turn to finding new ways to build its brand and shareholder value in the future. The company has been deploying much of its free cash to buying back its own shares, spending $141.8 million in Q1 under its standing $1 billion repurchase plan. Instead, perhaps the company could add a new page to its playbook by picking up another solid brand name to build a stronger presence in more "outdoorsy" sports to supplement its traditional stadium-sports strength. Whatever the firm chooses to do over the course of the coming months, investors should keep in mind that building value over time is the name of the game and Nike has proven again and again that it understands what it takes to win.