Description

COMPANY DESCRIPTION:
NKE is the leading athletic footwear and apparel brand in the world. Footwear is 65% of sales, and apparel is 35% of sales. North America represents approximately 47% of total Nike brand sales and 49% of pre-corporate EBIT. China and emerging markets are 24% of sales and 34% of pre-corporate EBIT. Direct to consumer sales represent approximately 26% of total NKE sales. Nike Brand product offerings are organized into nine key categories: Running, Nike Basketball, the Jordan Brand, Football (Soccer), Men’s Training, Women’s Training, Action Sports, Sportswear (our sports-inspired lifestyle products) and Golf. NKE is known as a performance brand, with its products driven by innovation and technology. Largest peer, Adidas, is known more as a casual, lifestyle brand with its products driven by marketing and branding. Nike also owns the converse and Hurley brands, which are run independently from the core Nike brands. 

 INVESTMENT THESIS:

• NKE is a very very good business. NKE has one of the strongest and most durable brands of any consumer company in the world. It is one of the leaders in product design and innovation, and it has the best management team in the athletic footwear industry. It has nearly 50% market share in athletic footwear. ROTIC is 35% and has been steadily increasing every year since the financial crisis. EPS growth has been positive every year since 1999 and book value per share has grown 16 of 19 years during this timeframe. The management team and culture at NKE are very highly regarded by investors and former employees
• NKE’s manufacturing revolution (ManRev) is very significant. NKE is redesigning its supply chain with a focus on automating the production process and locating much closer to the consumer. NKE has been working on this effort for many years and is likely significantly ahead of its competitors by a factor of 5-10x. ManRev provides two significant advantages – shorter product lead times and lower costs. Getting innovation to the consumer faster and reacting more quickly to trends and consumer feedback is a key competitive advantage that will drive sales. On the cost side, I beleive that automation and in-country production is likely to produce an 11% gross margin uplift on each pair. NKE has announced plans to roll this out across 25% of its production, which would imply ~30bps of gross margin expansion per year for the next three years. Also, I calculate that ManRev would contribute 475bps of gross margin expansion if it were rolled out across all of NKE’s footwear production. NKE is also doing ManRev in apparel, and the benefits would be additive to this amount.
• Other tailwinds are emerging and headwinds are diminishing.
• Inventory is starting to decline. North American inventories have been declining for the last four quarters, and overall inventory days just started to more materially decline last quarter.
• UAA competition in basketball is waning. UAA has over-distributed its product and moved away from its performance roots, and this has hurt its brand. UAA made an initial splash in basketball by signing Steph Curry by giving him UAA stock. This is less replicable going forward because the UAA stock price has underperformed. NKE has also replaced the manager of NKE basketball (who was responsible for losing Curry to UAA) with a much more capable leader. Kevin Durant has also made the Warriors a two-star team.
• ADS competition will likely wane. The retro and fashion trend that boosted ADS is waning. Retro cycles typically last 3 years and we’re entering the third year of the current cycle. ADS’s most popular shoe, the Stan Smiths, are now declining at FL and google trends for ADS have rolled over.
• Innovation is picking up. R&D spend has doubled over the last 3 years, and NKE has introduced/is introducing 4 new platforms in F17/F18. The last new platform introduction was in 2012.
• SG&A savings. NKE has gone through a sku/SG&A rationalization (called “edit to amplify”) whereby they’re eliminating the bottom 25% of skus that contribute only 1% to revenue. I believe that there is a lot of excess that NKE should be able to cut.
• FX pressure is waning. NKE sources predominantly in USD and sells in local currencies. Despite hedging, gross margins has been impacted by 230bps cumulatively for F16-F18 by the stronger USD (represents ~13% hit to EBITDA). Based on current fx rates, this will no longer be an incremental pressure on earnings after the current fiscal year.
• Lapping a big distribution disruption. In August 2017, NKE will anniversary the TSA bankruptcy, which I believe represented ~2.5% of NKE’s global sales before it liquidated.

RISKS:

Current trends are weak. Google trends are bad for NKE and about as bad as they’ve ever been over the last decade. Trends are equally negative for NKE’s global athletic peers. This is because we’re coming off an athletic/athleisure cycle. Athletic retailers have experienced slowing SSS, particularly in North America. But I believe that the decades-long casual/athletic trend will eventually trump athleisure rolling over. Also NKE’s innovation has picked up and should drive incremental growth. Approximately 55% of NKE sales are international (China and EM are 24% of sales, growing 15-25%), which has experienced less of an athletic cycle and are less mature markets. NKE should also see a 2% topline benefit from the wholesale – DTC shift alone. Also, 80% of NKE sales are mens, which are much more secular and less exposed to fashion cycles than womens product. NKE has a track record of fixing problems and responding well to threats and competition. NKE had challenges in China and in the basketball market in the early 2010s and was able to remedy these issues successfully. They specifically called out the “edit to amplify” strategy then as well. Generally, however, I think the stock can work with only 5.5-7.5% topline growth over the next three years versus an 8% CAGR over the last 18 years (the only years where NKE had growth under 6% were during recessions and periods of significant FX pressure).

Catalyst

earnings