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Considering the way the market reacted to Nike’s (NKE -0.39%) recent fiscal-second-quarter earnings report, it would seem the athletic footwear and apparel marker is a no-brainer buy. It beat analyst expectations on the top and bottom lines, boosted its full-year outlook, and made headway on its bloated inventory.
Yet it’s a more complicated picture than that, and as much as there is good news in Nike’s report, investors would do well not to rush into the stock. It’s never good to buy or sell a stock because the crowd is doing so, and smart investors know to look more closely at what’s occurring.
That’s not to say Nike isn’t a stock to buy, it just means a more careful examination is needed. So let’s dive in to see what’s happening.
Image source: Nike.
At first blush, the crowd is correct. Nike saw sales jump 17% to $13.3 billion compared to the year-ago period, well ahead of the $12.5 billion Wall Street was anticipating. It also reported earnings of $0.85 per share, trouncing forecasts of just $0.67 per share, which helped the apparel maker slightly raise its full-year sales forecast, which is now expected to grow by a low-teen percentage rates when excluding currency fluctuations, compared to its prior outlook of low double-digit percentage growth.
The improved guidance was helped in large part by Nike’s contention that it has gotten its inventory woes under control and the peak has passed, even though inventory was 43% above the year-ago figure and last quarter’s numbers were up 44%.
While it doesn’t seem like much of an improvement, Nike CFO Matthew Friend says the current quarter’s numbers were distorted by last year’s low inventory levels due to COVID issues, which closed factories in Vietnam. It’s now cutting orders from suppliers to “prioritize inventory health across the marketplace.”
Yet the numbers are still bloated even though Nike has been slashing prices on many of its products to clear out merchandise. Operating margins narrowed sharply in the quarter to 12.5% from 13.7% a year ago, and year to date they’re down to 13.5% from 15.8% last year.
Discounting helped sales surge 31% on a currency-neutral basis in North America, but were also helped by strong sales at wholesale partners such as Foot Locker (FL 1.78%).
The footwear retailer had previously despaired of having sufficient quantities of Nike products on its shelves, but when it reported earnings last month, Foot Locker said its own better-than-expected results were due in large part to having more Nike product on hand. President and CEO Mary Dillon said she expects Foot Locker “to end the year with a higher mix of Nike sales than we originally anticipated in addition to the strong demand we’ve seen across our portfolio.”
Still, Foot Locker will experience a negative impact in its fourth quarter as Nike represents a lower overall representation of its product line, around 55%. That’s due to Nike dedicating more resources to its own direct-to-consumer channels.
“Brand digital” sales, or those at its stores and on its website, jumped 34% on a currency-neutral basis, while Nike Direct sales were up 25% year over year.
Nike is still experiencing problems in China, with sales down 4%. It would have been worse, but footwear sales — its largest segment by far — were up 4%. But the country is finally relaxing its draconian zero-tolerance COVID policies, which could help sales rebound in future quarters.
Image source: Getty Images.
The risk for investors here is that while Nike’s business appears to be improving, it’s more a result of it heavily discounting leftover merchandise to move it, even though some product lines like its Jordan brand are still able to command full price.
If a recession comes next year as many analysts and economists predict, and Nike eases up on its promotional efforts, sales could be hurt, which could weigh heavily on its stock again. And if it keeps discounting, margins will suffer.
Shares are down 38% in 2022, even after the rally they enjoyed following the earnings report. And despite all that, they’re still not a particular value. Nike trades at 29 times trailing earnings and 27 times next year’s estimates. It goes for 3.5 times sales, more than 5 times its earnings growth rate, and almost 100 times the free cash flow it produces.
But Nike isn’t a bad stock to own. Investors shouldn’t care so much about trying to time a stock’s top or bottom, but rather should try to own a portfolio of quality companies, and hold for the long term. Still, don’t ignore valuation — just make such metrics part of your overall decision process.
Investors should not take big bites of Nike’s stock now, but instead nibble at its shares, becoming more aggressive if they show weakness over time.
Rich Duprey has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nike. The Motley Fool recommends Foot Locker and recommends the following options: long January 2025 $47.50 calls on Nike. The Motley Fool has a disclosure policy.
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