NKE Stock Overview
Nike Inc. (NYSE: NKE), has suffered a major sell-off amidst the S&P 500 bull market from the start of 2023. Recently, it recorded consecutive losses for 10 straight sessions, falling below the $100 price level. This marks the longest losing streak of the stock since its initial public offering in 1980. The stock is down 16.8% year-to-date (YTD) compared to the S&P 500 Consumer Discretionary Index up 29.1% YTD. I believe that this dip is transient and value investors may find NKE to be undervalued at its current price.
Reasons For NKE’s Selloff
Firstly, NKE has been dealing with higher inventory since the COVID-19 pandemic, owing to supply chain issues, which caused its products to arrive later than usual. Coupled with earlier ordering by retailers and an improvement in shipment transit times, NKE faced more unpredictable delivery timelines and received out-of-season products, leading to an inventory glut. To offload its inventory, NKE engaged in promotion campaigns and increased markdowns which placed pressure on its margins.
More recently, NKE stock was affected by the performance of sporting goods chains – Dick’s Sporting Goods (NYSE: DKS) & Foot Locker (NYSE: FL). FL reported disappointing results in Q2 FY2023 with sales decreasing by 9.9% compared to Q2 FY2022 and a net income loss of $5 million. Meanwhile, DKS showed a 23% decline in second-quarter profitability and moderated its outlook for 2023. Both companies’ shares closed ~25% lower after the earnings release announcement.
It is noted that both companies share a strategic retail partnership with NKE as part of the business’s wholesale efforts. NKE is the largest revenue contributor and a key brand partner in FL’s portfolio, estimated to make up 55% – 60% of the retailer’s total sales mix by 2026. As for DKS, NKE invested heavily in their partnership through joint advertisement campaigns and combined loyalty programs to further incentivise and attract consumers. Poor earnings performance from both retailers signals a slowdown in consumer spending and reflects a shifting of preferences from discretionary goods to services and experiences. Given NKE’s interdependence on its wholesale retailers, the negative sentiments spread over to NKE’s top line, which further contributed to its decline.
Basic Valuation of NKE
For the 10-year DCF model, I followed NKE management’s guidance of mid-single-digit growth for FY2024 and improved margins. This is due to more favourable freight rates and an improvement in markdowns. I calculated an implied valuation of $110.89 using the perpetuity growth method, which gives an upside of 8.3%.
Using scenario analysis, the conservative case returns a 46.2% downside while the optimistic case returns a 112.9% upside. The sensitivity analysis table also shows a comfortable margin of safety for NKE. At the current share price, I opine that NKE is priced below its intrinsic value.
NKE’s Rebound Fuelled By DTC Growth
Despite the setbacks facing NKE, I believe that it is capable of recovering from this correction. As management stated in its Q4 FY2023 earnings call, this is the “beginning of recovery from transitory headwinds”. It highlighted improvements in the areas that formed the bulk of transitory costs – a negotiation for ocean freight rates back to pre-pandemic levels and cutting down on markdowns. As inventory reaches normal levels, NKE should be able to cut back on SG&A expenses and naturally expand its margins.
In addition, NKE’s move towards a DTC (direct-to-consumer) model has seen tremendous growth and profitability. In Q4 FY2023, NIKE Direct (its DTC segment) reported revenue of $5.5 billion, up 15% compared to the prior year. This trumped wholesale revenue of $6.7 billion, which was down 2% compared to the prior year. According to Statista, NKE’s DTC sales as a share of total brand revenue have more than doubled from 18% in 2013 to 44% in 2023. Selling directly to customers has its own added benefits over wholesale, namely the elimination of middleman costs and full control over the customer experience. Success from the DTC branch should absorb losses in the wholesale segment while being the main driver for top-line growth.
Wholesale Segment Still Bears Significance To NKE
That is not to say that NKE is abandoning its wholesale segment. After cutting ties with retailers in 2017 to focus on DTC sales, NKE has reversed its course. With renewed collaborations and rebuilding of partnerships, NKE showed that it is cognizant of the role of wholesale distribution in its overall growth strategy. This represents a long-term commitment to an omnichannel approach. According to John Donahoe, CEO of NIKE Inc., “Consumers want digital and physical access. They shop across both channels. They want a monobrand and multibrand.” And so that is what has driven our marketplace strategy.” There is still a market of millions of NKE customers who seek a physical, multi-brand experience and prefer to shop at wholesale retailers. Therefore, this segment will be equally important to NKE in clearing its stock and expanding its market share over its rivals.
Conclusion
Overall, I believe that these events have not eroded NKE’s wide economic moat of brand recognition and global customer outreach. As such, investors need not panic as NKE’s competitive advantages will continue to allow it to exercise its price-setting ability and benefit from high customer loyalty.