Nike Is Down 34% From Its High. Time to Buy?

Nike's (NKE 0.19%) stock surged 12% in late December in response to its latest earnings report. For the second quarter of fiscal 2023, which ended on Nov. 30, the athletic footwear and apparel maker's revenue rose 17% year over year (27% in constant currency terms) to $13.3 billion and exceeded analysts' expectations by $740 million. Its net income stayed nearly flat at $1.3 billion, but big buybacks boosted its diluted earnings by 2% to $0.85 per share -- which also cleared the consensus forecast by $0.21.

Nike's earnings beat allayed some inflation-related fears, but this blue-chip stock remains 34% below its all-time high of $175.30 from last November. Is it finally time to hop aboard the bullish bandwagon again?

Image source: Getty Images.

Why did the bulls rush back to Nike?

To understand why Nike's stock soared, we should look back at its recent history. Nike's revenue declined 2% in fiscal 2020 (which ended in May of the calendar year) on a constant currency basis as the COVID-19 pandemic disrupted its brick-and-mortar sales. However, its revenue rose 17% in constant currency terms in fiscal 2021 as those headwinds dissipated.

That acceleration convinced many investors that Nike was poised for big post-pandemic gains, so its stock surged to a record high during the broader market rally throughout 2021. Unfortunately, that enthusiasm waned over the following year as China implemented rigid COVID lockdowns and inflationary headwinds curbed consumer spending across the world. As a result, Nike's revenue only rose 6% in constant currency terms in fiscal 2022.

But in the first half of fiscal 2023, Nike's prospects brightened. The growth of its Nike Direct (online and brick-and-mortar) business, which brought in over 40% of its revenue, accelerated again. Its strong sales in North America, Europe, and other markets also offset its declines in China.

Data source: Nike. Constant currency basis. YOY = Year-over-year.

For the full year, Nike expects its revenue to rise by the "low teens" on a constant currency basis, which represents a slight improvement from its prior guidance for "low double-digit" growth.

During the conference call, Nike CFO Matt Friend attributed its accelerating growth and rosier outlook to its market share gains across the wholesale market, "record highs for demand and traffic" during Black Friday and Cyber Monday in North America, "strategic pricing increases" across its higher-end products, and the stabilization of the Chinese market as it gradually ends its draconian zero-COVID policies.

But mind the inventories and margins

Nike's sales are stabilizing, but its inventories rose 44% year over year in the first quarter and 43% in the second quarter. The company attributed that increase to volatile transit times in North America, tough comparisons to its factory closures in Vietnam and Indonesia last year (which had lowered its inventories), and a decision to stock up on future products ahead of schedule.

However, Nike also admitted that it was aggressively clearing out its excess inventories with markdowns. That pressure, along with higher production costs and logistics expenses, caused its gross margin to decline 260 basis points year over year to 43.6% in the first half of fiscal 2023. Friend expects Nike's gross margin to contract 200-250 basis points to 43.5%-44% for the full year as it executes "ongoing liquidation actions in the second half" of the year.

Therefore, some of Nike's accelerating sales growth this year was clearly driven by those markdowns. To offset that pressure, Nike has been reining in its sales and marketing expenses, which only rose 10% year over year in the first six months of fiscal 2023 and consumed 30.9% of its revenue -- compared to 31.1% of its revenues in the first half of fiscal 2022. It also repurchased $2.6 billion in shares in the first half of the year to boost its EPS even as its net income growth stalled out.

The company didn't provide any exact earnings guidance for the full year, but analysts expect its EPS to decline 20% this year before rising 26% in fiscal 2024.

Is it the right time to buy Nike's stock?

Nike's stock got a bit overheated last year, but it still doesn't seem particularly cheap at 34 times forward earnings. Adidas and Under Armour -- which face many of the same challenges -- trade at 26 and 23 times forward earnings, respectively, as of this writing. Nike's paltry forward dividend yield of 1.3% also won't attract any serious income investors when the 10-year Treasury pays a safer and meatier yield of 3.7%.

In addition, even though Nike's stock has declined more than 30% from its all-time high, it remains up more than 60% over the past five years. Adidas and Under Armour both declined nearly 40% during the same period.

It's encouraging to see Nike stabilize its top-line growth, but it isn't out of the woods, and its stock isn't a screaming bargain yet. So for now, investors should stick with more recession-resistant plays until Nike's gross margins improve, its inventories stabilize, and its valuations align with its near-term expectations.