As the year comes to a close, investors are rightfully reassessing their portfolio strategies to be properly positioned for long-term gains. A completely different macroeconomic backdrop, characterized by higher inflation and interest rates, makes it extremely attractive to own safer, competitively advantaged businesses that generate real profits and cash flows.
A strong quarter
In its latest fiscal quarter (second quarter of 2023, ended Nov. 30), Nike reported revenue of $13.3 billion, up 17% year over year, and net income of $1.3 billion, essentially flat compared to Q2 2022. Both of these numbers topped Wall Street expectations, and the stock popped more than 10% following the news.
A key bright spot in the quarter was the 25% increase in digital sales. The company saw strong performance from its suite of digital applications, driving deeper connections with its customers. "Today, we have roughly 160 million active members who engage with us on a regular basis," CEO John Donahoe mentioned on the earnings call. Nike's ongoing Consumer Direct Acceleration initiative, aimed at creating a seamless shopping experience, looks to be paying off.
Despite a largely positive quarter from this leading apparel stock, shareholders can't ignore today's economic environment. Inflation, which is still surging right now, can dissuade consumers from spending money on discretionary purchases, a category Nike fits in. If things get worse and a recession does happen, then the business might take a temporary hit.
Making matters worse is Nike's still-elevated inventory level, now at $9.3 billion, up 43% from the prior-year period. Management blames the huge jump on supply chain issues last year that kept inventory tight for a period of time. The positive news is that this balance is lower than the $9.7 billion it was just three months ago.
A merchandise glut has forced Nike to implement more markdowns. And this has resulted in the gross margin shrinking from 45.9% in Q2 2022 to 42.9% in the most recent quarter. But I think the company should be able to fix its inventory problem over the next few quarters.
Matt Friend, Nike's CFO, expects "full-year revenue to grow low teens on a currency-neutral basis, an improvement from our low double-digit guidance in the prior quarter." The upgraded guidance signals optimism about the company's direction.
As of this writing, Nike shares are down more than 30% in 2022 and are now trading at a price-to-earnings ratio of 33. This multiple might look expensive, but it is lower than the stock's trailing-10-year average. Even when considering Nike's 35% drop from its all-time high set in November 2021, the stock has easily exceeded the performance of the S&P 500 and Nasdaq Composite indexes over the past decade. Owning a proven winner is a good strategy right now.
Investors who are comfortable with paying this valuation would get a business that is forecast to increase sales at a compound annual growth rate (CAGR) of 7.8% between fiscal 2022 and fiscal 2027, according to Wall Street consensus estimates. What's more, Nike's earnings per share are set to rise at a CAGR of 10.9% over the same time frame. This demonstrates a solid runway for the business to expand as we look ahead.
With interest rates kept low and loose monetary policy the norm over much of the past decade, businesses that were burning through cash still saw their stock prices rise, as borrowing capital was easier. The tides have turned in 2022, and this could be the macroeconomic backdrop that investors have to contend with for the foreseeable future.
As a result, it might be a smart idea to place more emphasis right now on identifying companies that are actually producing real profits and cash flow, as I alluded to earlier. Throw in a powerful brand that has been relevant for decades and will continue to be a consumer favorite for years to come, and it looks like owning Nike is a safe decision for your portfolio as we enter 2023.