Intrinsic Value Assessment of
NIKE (NKE)
OCTOBER 21, 2017 This article was written with David J. Flood from The Investor’s Podcast
ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.
IntroductionNikeisanAmericanmultinationalcompanyengagedinthedesign,manufacture,marketing,andsaleoffootwear,apparel,equipment,accessories,andservices.NikeiscurrentlyamemberoftheFortune500listwithamarketcapof$86.6billion.Itsrevenuesandfreecashflowsforthepreviousfinancialyearwerearound$34.3billionand$2.5billionrespectively.Thecompany’scommonstockhasfluctuatedbetweenalowof$49andahighof$60overthepast52weeksandcurrentlystandsat$53.IsNikeundervaluedatthecurrentprice?
TheIntrinsicValueofNikeTodeterminetheintrinsicvalueofNike,we’llbeginbylookingatthecompany’shistoryoffreecashflow.Acompany’sfreecashflowisthetrueearningswhichmanagementcaneitherreinvestforgrowthordistributebacktoshareholdersintheformofdividendsandsharebuybacks.BelowisachartofNike'sfreecashflowforthepasttenyears.
Asonecansee,thecompany’sfreecashflowhasbeenfollowinganupwardtrendgrowingatanannualrateofaround6%forthepasttenyears.Though,readerswillnoticethathistoricalfreecashflowslookalittlelumpyfromyeartoyear.Nike’srevenuesandnetincomehavebeenconsistentlygrowingforthelasttenyearswhichsuggeststhatthesefluctuationsinfreecashflowarearesultofthecompanyreinvestingearningstodrivegrowth.TodetermineNike’sintrinsicvalue,anestimatemustbemadeofitspotentialfuturefreecashflows.Tobuildthisestimate,thereisanarrayofpotentialoutcomesforfuturefreecashflowsinthegraphbelow.
Intrinsic Value Assessment of
NIKE (NKE)
ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.
Whenexaminingthearrayoflinesmovingintothefuture,eachonerepresentsacertainamountofprobability.Theupper-boundlinerepresentsa6%growthrate.Thisisbasedonthecompany’s10-yearhistoricalfreecashflowgrowthrateandhasbeenassigneda15%probabilityofoccurrenceduefactorsthatwilllaterbeaddressed.
Themiddlegrowthlinerepresentsa2%growthrateandisbasedontheassumptionthatfuturegrowthwillbemarginallylowerasthecompanycontinuestomature.Forthisreason,ithasa70%probabilityofoccurrence.Thelowerboundlinerepresentsa-3%growthrateinfreecashflowgrowthandhasbeenassigneda15%probabilityofoccurrence.Thislowerboundrateassumesthatthecompany’sfuturefreecashflowgrowthisimpactedbycompetitivepressureandadecreaseingrowthopportunities.Assumingthesepotentialoutcomesandcorrespondingcashflowsareaccuratelyrepresented,Nikemightbepricedata0.5%to1%annualreturnifthecompanycanbepurchasedattoday’sprice.We’llnowlookatanothervaluationmetrictoseeifitcorrespondswiththisverylowreturn.
BasedonNike’scurrentearningsyield,whichistheinverseofitsEV/EBITratio,thecompanyisprojectedtoreturnaround5%.Whilethisisroughlyinlinewiththeupper-boundlineinourfreecashflowarray,itisbelowthecompany’shistoricalmedianearningsyieldof6.70%,suggestingthatNikeiscurrentlyovervalued.Lookingatthecompany’sPEGratio,ametricfavoredbyPeterLynch,Nike'scurrentPEGratiois1.82.Thisisaboveafairvaluefigureof1,suggestingthatthecompanyisindeedovervalued.Takingallthesepointsintoconsideration,itseemsreasonabletoassumethatNikeisovervaluedrelativetotheS&P500andthemarket’shistoricalvaluationforthecompany.Furthermore,thecompanymayonlyreturnaround1%atthecurrentpriceiftheestimatedfreecashflowsareachieved.Now,let’sdiscusshowandwhytheseestimatedfreecashflowscouldbeachieved.
TheCompetitiveAdvantageofNikeNikehasvariouscompetitiveadvantagesoutlinedbelow:
• Branding.Nike’smostvaluableassetisundoubtedlyitsbrand.AccordingtothelatestreportfromBrandFinance,aleadingvaluationandstrategyconsultancyfirm,thecurrentvalueofNike'sbrandisestimatedtobeapproximately$32Billion.Thecompanyaggressivelyprotectsitsbrandandhasregisteredmultipletrademarksinover170jurisdictions.Italsoholdsaportfolioofcopyrightsandpatentswhichprotectitsproprietarycomponents,technologies,manufacturingtechniques,features
Intrinsic Value Assessment of
NIKE (NKE)
ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.
andindustrialdesign.WarrenBuffettisahugefanofcompanieswhichpossessacompetitiveadvantagestemmingfromintangibleassetssuchasbrandsastheyarethemostdifficultforacompetitortoreplicate.
• Bargainingpower.SinceNikecontractsthemanufactureofitsproductstolowwagecountrieswithinAsia,itcaneasilyswitchbetweensuppliers.Thisgrantsthecompanyhugebargainingpower.Thisisevidentinthefactthat,inthelasttenyears,thefirm’saveragegrossmarginhasbeen45%.
• Pricingpower.Whilealternativeproductsareavailablefromcompetingfirms,Nikecanchargeapremiumforitsproductsduetoitspowerfulbrandandcelebrity/sportsstarendorsementswhichcreatearelationshipofloyaltybetweenthecompanyanditscustomers.ThisisdemonstratedbythefactthatNikesignificantlyoutperformsitsclosestrivalAdidasandthefootwear/sportsclothingindustryatlarge.Thechartbelowdetailsthisoutperformancebasedonacomparisonofseveralcommonperformancemetrics.
Nike’sRisksNowthatNike’scompetitiveadvantageshavebeenconsideredlet’slookatsomeoftheriskfactorsthatcouldimpairmyassumptionsofinvestmentreturn.
• WhileNikedoespossessmultiplecompetitiveadvantages,thereisstillapossibilitythatoneofitsrivalscouldmountachallengetoerodeitscompetitiveadvantagesandmoveonitsmarketshare.UnderArmourhasbeenafiercecompetitorandcontinuestotakemoremarketsharefromNike.Thisisespeciallytruewithyoungergenerationsandareaswherefuturegrowthisimportant.
• Theemergenceofaseriouseconomiccrisissimilartothatwitnessedin2008couldmateriallyimpactthecompany’srevenuesandprofitsleadingtolowergrowthinthecomingyears.Nike’shistoricalperformancesuggeststhatitcanweatherthesetypesofstormscomfortably,butthisriskisstillworthyofconsiderationsbyinvestors.
• Afailuretocontinuetosecurehigh-qualityendorsementsfromathletes,sportsstarsandcelebritiescouldweakentheperceptionofprestigeandqualityassociatedwithNike’sproducts.This,inturn,wouldweakenbrandloyaltyandthefirm’spricingpowerwhichmayimpactrevenuesandearnings.
• AfailuretomaintainNike'sreputationandbrandimagecouldmateriallyimpactthefirm’seconomicperformanceinthefuture.Theemergenceofscandalsorbadpublicityassociatedwiththecompany’sbrandorproductswouldcertainlybedetrimental.Inaddition,anyadversepublicityrelatedtolegalorregulatoryactioncouldtarnishtheimageofthecompany,leadingtoaweakeningofthefirm’sbrandandprospectsofgrowth.
OpportunityCostsWheneveraninvestmentisconsidered,onemustcompareittoanyalternativestoweighuptheopportunitycost.Atpresent,10-yeartreasuriesareyielding2.16%,ifwetakeinflationintoaccount,therealreturnislikelytobecloserto1%.TheS&P500IndexiscurrentlytradingataShillerP/Eofx30,meaningitispricedforanearningsyieldof3.3%.Nike,therefore,appearstoofferalowerrateofreturnforinvestorswithahigheramountofrisk,andthereforeshouldbeavoided.
Intrinsic Value Assessment of
NIKE (NKE)
ThisassessmentwasconductedfromthetoolsprovidedinPrestonandStig’sIntrinsicValueOnlineTrainingCourse.
MacroFactorsInvestorsmustconsidermacroeconomicfactorsthatmayimpacteconomicandmarketperformanceasthiscouldinfluenceinvestmentreturns.Atpresent,theS&PispricedataShillerP/Eof30.Thisisover85%higherthanthehistoricalaverageof16.8,suggestingmarketsareatelevatedlevels.U.S.unemploymentfiguresareata30-yearlowsuggestingthatthecurrentbusinesscycleisnearingitspeak.U.S.privatedebt/GDPcurrentlystandsat199.6%andisatitshighestpointsince2009whenthelastfinancialcrisispromptedprivatesectordeleveraging.
SummaryThefutureforNikelooksfavorableifitcanmaintainitsdominantpositionwithinthefootwearandsportsclothingmarket.Althoughthecompanymaycontinuetoperformwell,owningnewequityinthecompanyatsuchhighpricesislikelytoproduceunfavorableresultswhencomparedtootheroptionsinthemarket.Managementistargetinga$50billionrevenuegoalby2020whichmaybeoverlyambitiousbutcertainlynotimpossible.IfthefirmcancontinueitsaggressiveexpansionintotheChinesemarket,whereithasalreadyachievedarevenuegrowthrateof24%overthepasttwoyears,itmaywellachievethistarget.Whilethecompanymaynotbeasoundinvestmentcurrentlyduetoahighprice,ithasgreatmanagement,asuperiorbrand,andexcellentoperations.It'sworthwatchinginthefuturetoseeifthemarketoffersabetteropportunityatamoreappropriateprice.
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