News this morning that the Sports Authority's bankruptcy is forcing Under Armour (NYSE:UAA) to cut its sales and earnings views for fiscal 2016 rocked that stock in early Wednesday trading. At last report, Under Armour stock is down 5% -- and that's the good news. The bad news is that Under Armour rival Nike (NYSE:NKE) could be in for even more trouble.
This morning, at least two separate analysts voiced worries about Nike stock. In part these worries relate to the same problems facing Under Armour. In part, they're because of Under Armour.
Read on, to learn three things you need to know.
Thing No. 1: Morgan Stanley is sick of Nike
For nearly three straight years, analysts at Morgan Stanley have been bullish about Nike stock, and rated it overweight (i.e., buy). This morning, however, Morgan Stanley finally admitted defeat, and cut its rating to neutral (with a $60 price target).
Merrill Lynch immediately followed suit, likewise assigning a neutral rating on the shares, and a $60 price target.
With Nike shares still selling for less than $55 per share, that appears to leave some room for improvement in the year ahead -- and yet both analysts have chosen to downgrade it. Why?
Thing No. 2: Why so glum, chums?
What's the reason for all the pessimism over Nike? This is more than a situation of just one second-tier athletics retailer calling it quits, liquidating its merchandise, and stepping out of the way so that other retailers can step in, claim its market share, and resume selling Nike (and Under Armour) merchandise hand over fist.
Rather, Merrill warns that Nike itself is losing market share -- for the first time since 2010, in fact, according to a write-up on TheFly.com. As TheFly relates, Merrill is seeing both Under Armour and Adidas (NASDAQOTH:ADDDF) steal market share from Nike in North America. And even where Nike products are still selling, Merrill notes, they're more often selling through "outlet store and off-price channels."
Morgan Stanley echoes these concerns, noting that "Q1 US core channel sales growth slowed to (1%) driven by retail bankruptcies, consumer's shift to online shopping [and] new entrants" into the sporting apparel market.
Thing No. 3: This is how Nike loses
Merrill Lynch notes that one reason Nike has lost momentum is because its "technical innovation is slowing" even as Under Armour and Adidas enjoy "continued momentum." But why this is happening -- and how Merrill can even tell that it's happening -- is something of a mystery.
Technical innovation, obviously, is a function of research and development spending by a company. But the thing is, out of the three companies mentioned in Merrill's report, only Adidas currently breaks out R&D spending in its financial statements. What's more, according to S&P Global Market Intelligence data, Adidas is actually cutting its R&D spending -- down 12% over the past two years, to just $151 million, or less than 1% of sales.
In contrast, Under Armour appears to lump R&D spending in with selling, general, and administrative expenses on its 10-K, while Nike classifies it as just another "cost of goods sold." It's impossible to break out R&D spending from these categories, but for what it's worth, Under Armour's SG&A expenses surged 70% over the past two years, while Nike's COGS increased only 16%.
The most important thing: What it means for the stock
If Nike is investing less in R&D, as Merrill's report suggests, while Under Armour is investing more in product development (as implied, but not proven by its rising costs), then that would seem to argue in favor of buying Under Armour stock rather than Nike. It would also suggest that Adidas's surge, despite minimal investment in R&D, is something that may fade over time.
The stocks themselves tell a different story, however. Priced at more than 67 times earnings today, and generating no free cash flow whatsoever, Under Armour is clearly the most expensive of these three stocks -- and arguably the one with the worst quality of earnings. Adidas, selling for a bit more than 30 times earnings, is second most expensive. Curiously, despite the double downgrade today, Nike stock at 25 times earnings actually looks like the cheapest of the bunch. That said, I have to conclude that based on everything I'm seeing here so far, it still looks like both Merrill Lynch and Morgan Stanley are right to downgrade it. 25 times earnings is too much to pay for Nike stock given its weak sales growth and underinvestment in R&D.
Just because Nike is the best bargain of the three doesn't make it a good enough bargain for thee.