Nike's overvalued stock defies weak growth and shrinking profits
This article attempts to compare NIKE against its two much smaller but formidable peers in the running shoe sector, namely Deckers Outdoor and On Holdings AG, review its performance over the last 10 years, and draw from there a somewhat informed inference as to whether Nike stock represents a buy or not.
Overview of the Three Companies
Let's first have a quick overview of the sizes of the three companies in terms of market cap, annual revenue and workforce.
| | NKE | DECK | ONON | | --- | --- | --- | --- | | Market Cap | 76.05B | 13.35B | 10.72B | | TTM Revenue | 46.5B | 5.4B | 3.8B | | TTM Net Income | 2.5B | 1.0B | 257M | | Employees | 77,800 | 5,500 | 3,963 |
NIKE commands ~6-7 times the market cap of DECK and ONON, and ~8-12 times the TTM revenue of them. However, although it commands ~10 times the TTM net income of ONON, its TTM net income is only ~2.5 times that of DECK.
Yet NIKE has a workforce that is ~15-20 times that of its two smaller rivals. Consequently, its revenue and net income per employee lag behind them by a wide margin, which probably suggests it is a mature and bloated organization.
Valuation of the Three Companies
As measured by stock price to various earning measures, whether TTM or forward earnings, GAAP or non-GAAP earnings, NIKE is valued higher by ~50% to ~150% than DECK and by ~50% than ONON. This pattern repeats itself in terms of free cash flow.
| | NKE | DECK | ONON | | --- | --- | --- | --- | | P/E Non-GAAP (FY1) | 33.56 | 13.67 | 20.16 | | P/E Non-GAAP (FY2) | 23.23 | 12.84 | 16.06 | | P/E Non-GAAP (FY3) | 18.91 | 11.57 | 12.22 |
NIKE is undervalued by ~50% in terms of price/sales, and that is probably due to its lower gross and net profitability.
Growth Trajectories of the Three Companies
Other than growing its revenue at the similar rates of inflation during the last 5 years or so, NIKE has no meaningful growth in terms of revenue, EBITDA or net income to speak of, whether during the last 3 years, or YOY, or in the next 12 months.
However, DECK and ONON are growing their revenues, EBITDA and net incomes across the board virtually all by double digits, whether during the last 3 years or 5 years, or YOY, or in the next 12 months.
| | NKE | DECK | ONON | | --- | --- | --- | --- | | Revenue Growth (YoY) | -5.03% | 9.16% | 30.01% | | Revenue Growth (FWD) | -1.88% | 10.68% | 27.26% | | Revenue 3 Year (CAGR) | -1.79% | 14.59% | 35.11% |
Profitability Profiles of the Three Companies
Now you may wonder why Mr. Market has assigned much higher price to earning ratios to NIKE whose business is not really growing. As you can tell from the table below, it is not because NIKE is more profitable than DECK or ONON, either.
As a matter of fact, NIKE lags DECK and ONON by ~16% - 20% in gross margin, ~6% - 17% in EBITDA margin. While it manages to outperform ONON on return on equity by ~4.5%, it lags behind DECK by a wide margin of over 20% there. In terms of return on total assets and total capital, the gaps there are similarly wide.
| | NKE | DECK | ONON | | --- | --- | --- | --- | | Gross Profit Margin | 41.13% | 57.54% | 62.83% | | EBITDA Margin | 8.19% | 25.30% | 13.93% | | Return on Equity | 17.95% | 39.69% | 13.47% |
Nike's 10 Year Financial Performance
Now that we have finished comparing Nike against its much smaller but apparently more profitable and faster-growing peers, whose stocks are also valued much lower, let's review NIKE's own performance during the last 10 years to see how NIKE has arrived at this point, and whether NIKE is likely to turn around to "deserve" its apparently higher valuation.
| Year | Revenues | Revenue YOY | Gross Profit | Gross Profit YOY | Net Income | Net Income YOY | Diluted EPS | | --- | --- | --- | --- | --- | --- | --- | --- | | May 2017 | 34,350 | 6.10% | 15,312 | 2.28% | 4,240 | 12.77% | $2.51 | | May 2018 | 36,397 | 5.96% | 15,956 | 4.21% | 1,933 | (54.41%) | $1.17 | | May 2019 | 39,117 | 7.47% | 17,474 | 9.51% | 4,029 | 108.43% | $2.49 | | May 2020 | 37,403 | (4.38%) | 16,241 | (7.06%) | 2,539 | (36.98%) | $1.60 | | May 2021 | 44,538 | 19.08% | 20,001 | 23.15% | 5,727 | 125.56% | $3.56 | | May 2022 | 46,710 | 4.88% | 21,479 | 7.39% | 6,046 | 5.57% | $3.75 | | May 2023 | 51,217 | 9.65% | 22,292 | 3.79% | 5,070 | (16.14%) | $3.23 | | May 2024 | 51,362 | 0.28% | 22,951 | 2.96% | 5,700 | 12.43% | $3.73 | | May 2025 | 46,309 | (9.84%) | 19,790 | (13.77%) | 3,219 | (43.53%) | $2.16 | | TTM | 46,513 | (5.03%) | 19,132 | (12.66%) | 2,524 | (48.34%) | $1.71 |
What Now?
The recent underperformance of both NIKE's business and stock has not resulted from a cyclical wobble, as DECK and ONON have both been growing at double digits during the same time period. If you look at the above table, especially the YOY growth rates, you can tell that this is a business that has stopped growing and has seen meaningful earnings erosion. Furthermore, it is clearly not cutting its SG&A enough in the face of revenue decline.
However, NIKE's stock valuation has not yet fully adjusted to its slower business growth , or its subpar profitability profile despite the fact that it had declined from its peak level around $170s to low $50s now, essentially where the stock traded in 2015. Why? it still trades at ~30× earnings and over 20× EBITDA.
That is the first and most important disconnect between the stock price and lackluster business fundamentals, unless Mr. Market is essentially betting on a quick and meaningful turnaround of its business.
Conclusion
Capital should be allocated to businesses that are growing faster and/or more profitable than its peers, and are priced fairly relative to its probable potential to grow and earn profits to compensate for risks.
Nike is a large, mature company with declining earnings, subpar margins relative to peers, yet its stock is traded at a higher valuation that apparently assumes a degree of recovery that we can only hope for.
As stated in this previous article,
I no longer wish to bet on such a turnaround [of NIKE] (or a turnaround of large-cap companies in general). The reason is simple: whether lifting such a large ship can be done is far more difficult than an average individual investor can intelligently assess. Equally importantly, NIKE's sheer size of $90 billion market cap works against it, particularly for individual investors seeking nimble small- or mid-cap opportunities capable of delivering five- or ten-fold returns in the next 5-10 years. How can NIKE sell that many more sneakers to the world?
For the above reasons, I rate NIKE a SELL even though NIKE's market cap has declined further down to ~$75B now.
