Nike’s Fundamentals are Not As Strong as Its Branding.

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Company Overview

Nike (NKE) is facing difficulties living up to investors’ expectations following a turbulent 2021 in which Nike failed to meet market demand due to supply chain problems. The failure to meet demand led to the cancelation of orders for the winter holiday season ’21 and 2022.

Photo by Thomas Serer on Unsplash

As companies worldwide shifted to work-from-home, the demand for Nike’s leisurewear increased. A recent Ipsos poll suggests 88% of Canadians enjoyed working from home more in 2021, hinting at the possibility of working from home becoming the norm.

But despite the demand for Nike’s leisurewear increasing and its extensive portfolio of sister brands, investors are on pins and needles looking at the interest rate hikes, Nike’s performance in Greater China, its supply chain issues, and its current trading price compared to its sector peers.

Despite Nike’s growing digital channel, sustainability efforts, and retail partnership with DICK’s Sporting Goods (DKS), the company faces serious challenges.

Investment Thesis

Despite the bullish sentiment at the beginning of the year, Nike’s stock plunged on the 4th of January 2022 and traded relatively flat. Year over year return on investment is a weak 3.38% compared to Lululemon’s 7.89% and Adidas’s 9.12%.

NKE 1Y Chart (Seeking Alpha)

My bearish projection stems from the following sources.

  • The supply chain congestion highlighted how fragile Nike’s supply chain was, resulting in a -36% and -8% revenue decline in GC and APLA. The rippling effects will continue affecting Q1/2 2022 revenues as well.
  • Interesting rate hikes will stunt future growth. Like other industries, interest rate hikes will heavily impact Nike in the short and long term.
  • Nike’s price-to-earnings ratio is relatively higher than its sector peers.

The Greater China Market is Shrinking

Nike could not adapt to the Covid-related factory closures, negatively affecting supply. The closures of Vietnamese factories did not affect North America and EMEA as much as Greater China and APLA due to higher in-transit inventory resulting in sales of the prior season’s supply arriving late due to longer transit times. The in-transit inventory sales led to North American / EMEA revenue being “inflated” compared to GC and APLA.

In Q2, the overall revenue in GC declined by -24%. The wholesale revenue declined by -27%, and NIKE Direct sales declined by -21%. Both the digital and physical channels contributed to the falling revenue.

The -27% decline in revenue stemmed from Nike’s SNKRS app, which was down by -50% in sales from the previous year.

The revenues generated by SNKRS, independent of the entire digital channel, are unavailable. Still, the steep decline signals that the Chinese sneaker market is declining. Overlooking this ominous signal and focusing entirely on North American growth would be myopic since the U.S. footwear market was valued at $94,527m in 2022, making the Chinese revenue decline look even more intimidating in comparison.

(Note: the data source differentiates between Athletic Footwear and Lether Footwear, Sneakers and Other Footwear).

Higher Interest Rates Stunting Future Growth

With current inflation rate estimates of around 7%, analysts anticipate further interest rate hikes as a regulatory measure to stabilize inflation. Increased interest rates will lead to less access to capital, thereby stunting future growth.

On the other hand, as much as soaring interest rates negatively impact businesses, analysts see Nike as an interest-insensitive company. As a result, higher interest rates will not affect Nike directly, giving it more time to adapt.

In the long term, however, Nike will find itself experiencing higher borrowing costs pointing to slower growth in the future. Furthermore, the demand for Nike’s activewear and footwear will decline due to slower economic expansion — an ominous signal for an already overvalued company.

Even if the demand for Nike’s activewear remains high or increases, the rippling effects of future economic stagnation may nullify the rising demand making higher interest rates a severe inhibitor of long-term growth.

Valuation & Competition

Nike’s picture is bleak when comparing the standardized prices of comparable assets in the consumer discretionary sector.

Nike’s EV/R ratio is higher than the industry median of 1.38x, sitting at 5.03x. The P/E ratio is currently at 38.04x compared to the sector median of 12.66x. And the P/CF ratio is sitting at 32.05x compared with the 11.47x sector median.

I approximated Nike to its sector competitors for a visual representation, selecting companies with a neutral (greater than 2.0) quant rating, sorting the top ten companies by market capitalization. I then compared the footwear icon to other footwear and apparel accessories and luxury goods sector companies. The results speak for themselves — Nike is currently one of the most overvalued companies in its sector Lululemon being the two other outliers.

Nike’s Sector. (Curated by Kacper Ruta; data source: Seeking Alpha)

The Bottom Line

Despite Nike’s iconic AF-1’s continuing to rake in $800m a year after being on the market for several decades, the Oregon footwear giant is not an attractive company to invest in at its current price. Nike is the third most overvalued company in its sector. Despite considering the increasing demand for leisurewear, investors should stay clear of Nike at its current price. Furthermore, Nike’s performance in North America should not overshadow Nike’s poor performance in Greater China, where revenue declined by 27%. With increasing interest rates, Nike’s share price is on a trajectory to fall to where the price matches the company’s value.