Nike (NKE) - Get Report is still trading below its all-time-high, but it’s also trading at a richer valuation on currently depressed earnings. And Morgan Stanley analysts see a brighter future on the “the other side” of the pandemic.
Nike shares have rebounded 56% from their 2020 bear market low on March 23 of $62, a far better gain than the S&P 500’s less than 40% gain. State and country reopenings, economic stimulus and Nike’s leadership position in e-commerce in retail and apparel has powered earnings estimates higher of late. Retail brands with strong digital presences in both food and apparel have seen their stock prices and earnings estimates hang in there. As of July 1, Nike trades at $97 a share, just 6% below its all-time-high hit in mid-January.
Nike’s fiscal fourth-quarter results, reported in June, showed a massive decline in revenue and a net loss, all also worse than expectations, as COVID struck in the quarter. And off of depressed earnings estimates for the coming year, the stock now trades at 41 times those estimates, after having hung around a fairly rich 30 times, pre-virus. But Nike’s ability to sell digitally and the V-shaped recovery in China, a tremendous top-line growth area for Nike, are pushing longer-term estimates higher. Nike is poised to compound earnings per share annually at a 26% clip for the next four years, according to FactSet consensus estimates, making the valuation look not so stretched.
And “Robust Q4 2020 digital results and the ‘consumer direct acceleration plan’ solidify our belief in Nike’s long-term margin expansion story,” wrote Morgan Stanley analyst Kimberly Greenberger in a note. “However, we lower our 2021 forecast on lingering COVID-19 headwinds.” First off, states are pausing reopening plans as infections surge again, which would pressure Nike’s fairly resilient business. Secondly, Nike’s digital sales in the recent quarter were 30% of the total and grew 75%, as consumers stayed home. Thirdly, the “consumer direct acceleration plan” is management’s plan to accelerate its direct-to-consumer (digitally centric) business model, which carries far higher gross margins than the traditional business does.
And much of the earnings growth investors are hoping to see in the company comes from margin expansion. Revenue growth will certainly be strong -- in the low teens in percentage terms for some time -- but the margin expansion can see profits through.
On top line growth, Greenberger expects management to execute on its projection that 50% of all sales will be digital by 2023, higher than the company’s prior projection of 30%. This would boost margins and the highest growing area of the sales will likely be in China. In the next few years, Nike’s operating margin is expected to grow from around 10% to around 13%, which has begun to be reflected in the stock.
Interestingly, if we call 2022 the “normalized” year of revenue earnings, Greenberger looks for revenue of $42 billion, against Wall Street's $44 billion for the $121 billion market cap company. And long-term, she looks for margins to sit at 13%, while Wall Street sees that growing to 15% after 2022. Meanwhile, Greenberger’s price target rose to $121 from $119, while the average price target on Wall Street is a still bullish $111. But Greenberger’s implied multiple on 2022 EPS is 37 times, versus the consensus of 34 times. Part of the full valuation is a company’s cost of capital (its debt and equity) and a lower cost of that capital increases the value of the profits. Greenberger explicitly mentions she uses a 5.7% cost of capital to discount Nike’s cash flows, which may be slightly low compared to consensus, boosting her multiple on near-term earnings.
The point: Nike shares have risen considerably, may be pressured in the near-term, but could be a solid hold for a few years, as the company continues to grow post-pandemic.