Collin J. Myers

Memorandum #4

Collin J. Myers BUS-458

Spring 2013

Collin J. Myers

II

NIKE Memorandum #4

At NIKE everything starts with the consumer. Consumer insights enable NIKE to

innovate and add strength to the NIKE portfolio - footwear, apparel, category, brand and

distribution.1 NIKE strives to communicate with the consumer in an effort to deliver the

most innovative products on the market. NIKE has built one of the most recognizable

brands in the world through its constant innovation strategy, applied not only to their

products but also to all areas of business. Without innovation, NIKE would not be what it

is today, making innovation NIKE’s greatest source of competitive advantage.

NIKE’s strategy is to achieve long-term revenue growth by creating innovative

“must have” products (NIKE Flyknit Technology & Fuel Band), building deep personal

consumer connections with their brands (NIKE Digital), expanding into new spaces

(Emerging Markets), and delivering compelling consumer experiences at retail and

online (DTC Businesses).2

The athletic footwear, apparel, and equipment industry is keenly competitive in

the United States and on a worldwide basis. The intense competition stems from the

rapid changes in technology and consumer preference.3 Characteristics that constitute

success in this industry are: performance and reliability of products (shoes, apparel, and

equipment), new product development, price, product identity through marketing and

promotion, and customer support and service.4 Due to the fast operating speed of the

1 http://investors.nikeinc.com/files/Nike%20Inc.%20Q213%20Earnings%20Release%20Transcript_v001_w20vs9.pdf 2 NIKE FY 2013 Q2 Earnings Summary 3 http://investors.nikeinc.com/files/doc_financials/AnnualReports/2012/docs/nike-2012-form-10K.pdf 4 http://investors.nikeinc.com/files/doc_financials/AnnualReports/2012/docs/nike-2012-form-10K.pdf

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industry, technologic change must be embraced. As the active movement is on the rise,

NIKE is positioned to see profits well into the future.

This paper will include an analysis of financial ratios that are important to the

core values of NIKE. These ratios reflect NIKE’s direction and overall purpose as a

company; they will reflect how successfully NIKE is fulfilling their mission by being

compared to Adidas and the performance of the S&P 500. I will then provide a future

investment outlook based on the effectiveness of NIKEs‘ key financial statistics.

Growth

A key statistic that takes a view into the overall growth performance of NIKE is

their five-year compound annual growth rate (CAGR). For fiscal years 2008-2012, NIKE

boasts a CAGR of 8% [Fig. 1].5 This shows that NIKE’s investing activities have been

successful and the company as a whole

is growing in terms of revenue. This

means that NIKE is succeeding in its

mission to deliver long-term sustainable

growth. The ratio downplays certain

operating segments, but with a highly

diversified portfolio like NIKE’s the

CAGR is an adequate ratio to show

growth across all segments. In comparison, during this same period (2008-2012) The

S&P 500 had a CAGR of -0.17%.6

5 http://investors.nikeinc.com/files/doc_financials/AnnualReports/2012/index.html#select_financials 6 http://www.moneychimp.com/features/market_cagr.htm

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Diluted Earnings per share is a commonly used measurement of success in the

industry. With the exception of the financial crisis in 2009, NIKE has delivered a yearly

increase in their diluted EPS [Fig. 2]7. Increases in NIKE’s diluted EPS derive from

strong revenue growth and gross margin expansion. A positive five-year CAGR and an

increase in Diluted EPS show that NIKE is performing well in sales as well as on the

equity markets. Again showing that NIKE is positioning itself well for sustainable long-

term growth. Figure 2

Liquidity

Due to NIKE’s recent setbacks in their Chinese markets, it is vital to look at the

change in their inventory turnover. It can be seen that NIKE’s 2011 inventory turnover

reflects a slight increase [Fig. 3]8. This is a result of lower Chinese sales in 2011

because NIKE failed to produce clothing that supplied the ‘fit’ demand of the Asian

demographic.9 Since then NIKE has been working to refine their Chinese markets by

creating special seasonal releases (Chinese New Year, etc.) and manufacturing clothes

that accommodate the Asian body better.10 The normality in NIKE’s 2012 turnover is a

result of the progress made in China but mostly can be attributed to the advancement in

the world economy and an increase in consumer confidence.11

7 http://investors.nikeinc.com/files/FY12%2010%20Year%20Financial%20History%20-%20NIKEINC%20(Post%20Stock%20Split)_v001_h6tt73.pdf 8 http://investors.nikeinc.com/files/FY12%2010%20Year%20Financial%20History%20-%20NIKEINC%20(Post%20Stock%20Split)_v001_h6tt73.pdf 9 http://investors.nikeinc.com/files/doc_financials/AnnualReports/2012/docs/nike-2012-form-10K.pdf 10 NIKE FY 2013 Q2 Earnings Summary 11 NIKE FY 2013 Q2 Earnings Summary

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Solvency

Taking a look into NIKE’s debt to equity ratios offers insight into their financial

strength. Over the past five fiscal years, NIKE has produced on average an incredibly

low debt to equity ratio of .068 [Fig. 4].12 As you can see in the chart below, this well

outperforms the industry average. Over the same period, Adidas produced an average

debt to equity ratio of 1.2.13 This shows that NIKE is more equity financed than the

industry and Adidas. Being more equity financed lowers NIKE’s exposure to the interest

costs associated with using debt financing and the interest costs of being a global

company. NIKE’s debt to equity represents a solid model for long-term sustainable

growth and a great deal of financial leverage.

Figure 4

12 http://www.stock-analysis-on.net/NYSE/Company/Nike-Inc/Ratios/Long-term-Debt-and-Solvency#Debt-to-Equity 13 NIKE FY 2013 Q2 Earnings Summary

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It can be seen in the chart below that over the past few years NIKE has become

less debt financed [Fig. 5].14 NIKE has become more equity financed as a result of high

ROE and ROA delivering high levels of return and cash flows from operations.

Figure 5

Profitability

A large contributing factor to NIKE’s success and the athletic apparel & footwear

industry is the availability of outsourcing and the use of sub contractors to manufacture

their products. This is the only way that NIKE and other competitors have been able to

achieve such high profit margins. NIKE’s high profit margins represent one corner of

14 http://www.stock-analysis-on.net/NYSE/Company/Nike-Inc/Ratios/Long-term-Debt-and-Solvency#Debt-to-Equity

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their foundation for success. It can be seen in [Fig. 6]15, NIKE over the past 5 years has

continually outperformed the industry with its Net Profit Margins. This means that

NIKE’s outsourcing strategy is the most efficient, allowing them to control costs better

than their competitors.

Figure 6

NIKE’s gross margin is also a very important measure of their success. NIKE

strives to expand into new markets and is subject to many expenses due to this fact.

Over the past three years, NIKE’s gross margin has steadily decreased [Fig. 7].16 This is

associated with a rise in raw material costs, labor costs and the expansion of the brand

into lower margin geographies (Emerging Markets).17 Another important contribution to

the decrease in gross margin deals with NIKE’s mission to deliver the most innovative

products. The launch of NIKE Digital in 2010 is a large source of R&D spending that

ultimately lowers their gross margin in the short term. Despite the drop in gross margin,

15 http://www.stock-analysis-on.net/NYSE/Company/Nike-Inc/Ratios/Profitability#Net-Profit-Margin 16 http://investors.nikeinc.com/files/FY12%2010%20Year%20Financial%20History%20-%20NIKEINC%20(Post%20Stock%20Split)_v001_h6tt73.pdf 17 http://investors.nikeinc.com/files/NIKE,%20Inc.%20Q313%20Earnings%20Release%20Transcript_v001_c97v0n.pdf

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NIKE has still been able to deliver increases in diluted EPS (discussed in growth

section).

Figure 7

The final two aspects of NIKE’s financial performance that truly make it stand out

from Adidas are: Return on Equity (ROE) & Return on Assets (ROA). NIKE over the

past 5 years held an average of 21.58% annual ROE [Fig. 8].18 Adidas over the past 5

years held an average of 11.9% annual ROE [Fig. 9].19 This shows that NIKE’s mission

to innovate every aspect of their company including management effectiveness to

generate income is working.

Figure 8

Figure 9

During this same five-year period, NIKE held an average annual ROA of 14.16%

[Fig. 8].20 Adidas held an average annual ROA of only 5.36% over the past five years.21

18 http://investors.nikeinc.com/files/FY12%2010%20Year%20Financial%20History%20-%20NIKEINC%20(Post%20Stock%20Split)_v001_h6tt73.pdf 19 http://www.adidas-group.com/en/investorrelations/financial_data/default.aspx 20 http://investors.nikeinc.com/files/FY12%2010%20Year%20Financial%20History%20-%20NIKEINC%20(Post%20Stock%20Split)_v001_h6tt73.pdf

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The difference seen in ROA is another explanation of NIKE’s strength in the market

place. It also reflects NIKE’s constant drive to innovate and utilize all of its assets as

efficiently as possible. Both of the ratios explained above are in line with NIKE’s mission

to deliver long-term sustainable growth. Future Forecast Nike operates a well-recognized brand worldwide and provides products

perceived as top quality by consumers and businesses across the globe. The stock has

been on a monster run over the last few years and is now trading at all-time high prices

($60.08), supported by strong earnings and revenue growth. NIKE’s financials are quite

healthy and in line with there future mission; to deliver sustainable long-term growth. It

can be seen in [Fig. 10], that NIKE’s share price has outperformed the S&P 500 over

the past five years. Figure 10

Despite challenges in Europe, China and the US, NIKE has continually

outperformed its competitors and the S&P 500 [Fig. 11].22 NIKE has only 20% exposure

to the Western European markets compared to Adidas having nearly 35% of sales in

21 http://www.adidas-group.com/en/investorrelations/financial_data/default.aspx 22 http://finance.yahoo.com/q?s=nke&ql=1

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Western Europe.23 NIKE is the leading Athletic Company in North America and China.

As a result, NIKE’s revenues outperform the heavily European sales based Adidas.

Figure 11

NIKE has identified its areas of future growth, which lie in Digital, and refining

their Chinese market. The positive side to these future goals is that NIKE is already well

established in both these markets. NIKE has been in China for decades and the image

of the NIKE and Jordan brands is well respected and viewed as a premium brand.

Despite having negative growth in China over the past year, NIKE has continued to

23 http://www.investopedia.com/stock-analysis/032213/nike-continues-just-do-it-nke-ua-dks-lulu-addyy.aspx

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deliver a high-diluted EPS [Fig. 2]24, increase in dividends, and increased revenues [Fig

1.].25

The digital community represents the future of many industries, not just NIKE’s.

NIKE has the human capital and free cash flows to make the investments in adapting

digital technology into their products. As these new digital products hit the market, I

have the strongest belief that profit margins will increase due to NIKE Digital’s success.

NIKE also has high bargaining power due to their strong history of innovation, which will

help create strategic partnerships with tech companies. Partnerships will enable NIKE to

grow to the next level and continue to set the bar for their competitors.

Overall, NIKE and Adidas are both wise companies to invest in because of the

markets they compete in. With active lifestyles on the rise both companies are well

positioned to succeed. Active lifestyles and brand communities are the future of the

NIKE and Adidas. It will not be a sprint between the two companies but rather a cross-

country battle into the future. Both companies have healthy financials at this point;

success will depend on adapting to the new strategic inflection points in the industry

such as digital adaptation. With annual increase in revenue [Fig. 1], dividends, ROE

[Fig. 8], and investment into digital technology; NIKE is a better stock to hold in the long

run.

24 http://investors.nikeinc.com/files/FY12%2010%20Year%20Financial%20History%20-%20NIKEINC%20(Post%20Stock%20Split)_v001_h6tt73.pdf 25 http://investors.nikeinc.com/files/FY12%2010%20Year%20Financial%20History%20-%20NIKEINC%20(Post%20Stock%20Split)_v001_h6tt73.pdf

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References NIKE, Inc. “Ten year financial history”http://investors.nikeinc.com/files/FY12%2010%20Year%20Financial%20History%20-%20NIKEINC%20(Post%20Stock%20Split)_v001_h6tt73.pdf http://www.investopedia.com/stock-analysis/032213/nike-continues-just-do-it-nke-ua-dks-lulu-addyy.aspx http://finance.yahoo.com/q?s=nke&ql=1 Adidas Group, Key Financial History http://www.adidas-group.com/en/investorrelations/financial_data/default.aspx http://www.stock-analysis-on.net/NYSE/Company/Nike-Inc/Ratios/Profitability#Net-Profit-Margin NIKE, Inc. “FY 2013 Q3 Earnings Release Conference Call.” March 21, 2013 http://investors.nikeinc.com/files/NIKE,%20Inc.%20Q313%20Earnings%20Release%20Transcript_v001_c97v0n.pdf NIKE FY 2013 Q2 Earnings Summary http://www.stock-analysis-on.net/NYSE/Company/Nike-Inc/Ratios/Long-term-Debt-and-Solvency#Debt-to-Equity CAGR Calculator.12 http://www.moneychimp.com/features/market_cagr.htm NIKE, Inc. 2012 Annual Report http://investors.nikeinc.com/files/doc_financials/AnnualReports/2012/docs/nike-2012-form-10K.pdf

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