May 6, 2006
Equity Research
Nike Inc. (NKE-NYSE)
Current Recommendation BUY
Current Price (06/05/06) $80.31
Six- Month Target Price $87.40
OUTLOOK
Despite the leadership void created after the retirement of its founder Phil Knight, Nike continued to post solid financial performance. Our discounted cash flow model suggests target price of $90.53 while comparable company approach hints a target price of $87.40. Hence, we rate the stock a BUY.
Industry Footwear & Apparel
Financials
Revenue
(in millions of $)
Q1 Q2 Q3 Q4 Year
(Mar) (Jun) (Sep) (Dec) (Dec)
2004 3024.9A 2837.1A 2904.0A 3487.1A 12253.1A
2005 3561.8A 3148.3A 3308.2A 3721.4A 13739.7A
2006 3862.0A 3474.7A 3612.8A 15154.1E
2007 16174.0E
Earnings per Share
Q1 Q2 Q3 Q4 Year
(Mar) (Jun) (Sep) (Dec) (Dec)
2004 $0.98 A $0.66 A $0.74 A $1.13 A $3.51 A
2005 $1.21 A $0.97 A $1.01 A $1.30 A $4.49A
2006 $1.61A $1.14 A $1.24 A $1.40 E $ 5.39 E
2007 $ 5.60E
SUMMARY DATA
52-Week High $91.54
52-Week Low $76.53
One-Year Return (%) -3.40
Beta 0.75
Average Daily Volume (sh) 1,558,940
Shares Outstanding (mil) 2580.62
Market Capitalization ($bil) $20.77 Short Interest Ratio (days) 2.9
Institutional Ownership (%) 74.4
Insider Ownership (%) 25.6
Annual Cash Dividend $1.24
Dividend Yield (%) 1.60
5-Yr. Historical Growth Rates
Sales (%) 8.84
Earnings Per Share (%) 19.50
Dividend (%) 17.92
P/E using TTM EPS 15.18
P/E using 2006 Estimate 14.90
P/E using 2007 Estimate 14.34
Business Description
Nike is the largest seller of footwear and athletic apparel in the world with revenues of $13.7 billion in the last fiscal year. Its principal business activities involve designing, developing and marketing footwear, apparel, equipments and accessory products. NIKE sells its products to retail accounts and through a mix of independent distributors, licensees and subsidiaries in over 160 countries around the world.
The company states that its athletic footwear products are designed primarily for specific athletic use, although a large percentage of the products are worn for casual or leisure purposes. Currently, Nike’s top selling footwear products include: Running, cross-training, basketball, soccer, sport-inspired urban shoes, and children’s shoes.
Nike also sells sports apparel, sports inspired lifestyle apparel, as well as athletic bags and accessory items. NIKE’s apparel and accessories are designed to complement its athletic footwear products. They feature the same trademarks and are sold through the same marketing and distribution channels. Nike also sells a line of performance equipment including golf clubs, sport balls, eyewear, timepieces, electronic media devices, skates, and other equipment designed for sports activities. The chart alongside shows the contribution to FY05 revenues from
each product line.
Nike is truly a global company operating in over 160 countries with US market Source: Nike annual report
accounting for 46% of its sales. According
to the recent data available, Nike has 137 factories in the Americas (including the US), 104 in EMEA, 252 in North Asia and 238 in South Asia, providing more than 650,000 jobs to local communities. This total excludes the amount of jobs provided by manufacturers of Nike subsidiaries.
Virtually all of the company's products are manufactured by independent Source: Nike annual report
contractors and all footwear and apparel products are produced outside the U.S., while equipment products are produced both in the U.S. and abroad.
A brief history of Nike
While pursuing an MBA from Stanford in the early 1960s, as a long term summer project Phil Knight had to come up with a small business plan on marketing. Being an athlete Knight wanted to do something that would show his passion towards sports. He always knew that professional sports shoes made in USA were expensive. The idea was to bring shoes in from Japan and sell them in America. In 1963, Knight got the opportunity to travel to Japan as a world tour. While on the tour, Knight planned a meeting with a small shoe manufacturing company called Tiger that was a subsidiary of Onitsuka Company. During the meeting the representatives asked for the company that Knight represented and moments after that, he came up with the name Blue Ribbon Shoes. The representatives liked what Knight proposed and he got his first order.
Phil Knight and Bill Bowerman came together for Blue Ribbon Shoes that would import athletic shoes from Japan and sell them at affordable rates in US. They used to sell shoes from the back of their van at high school track meets.
In 1965 they employed their first full time employee Jeff Johnson a high school track rival. In the late 70’s they had surpassed the $1 million in sales figure and Knight decided to venture into the business himself and thus the name Nike was born. In the spring of 1972, Nike produced its first shoes with the swoosh symbol. The swoosh symbol was designed by Carolyn Davidson, a graphic designing student for just $35 (but was later handsomely rewarded by Knight). Nike means the Goddess of Victory, in the Greek mythology. She sat next to Zeus in the Olympic pantheon. The word Nike is synonymous with honored victory.
Company Acquired
Based in
Products include
Cole Haan
Maine
Casual wear, apparels for men & women
Nike Bauer Hockey
New Hampshire
Hockey ice skates, apparels, equipments in line skating, rollerblading.
Hurley
California
Surfing, skate boarding, snow boarding. Targeting the youth.
Converse
Massachusetts
athletic & casual footwear & apparel
In 1973, Steve Prefontaine, became the first professional athlete to wear Knight’s athletic shoes under the brand name ‘Nike’. In 1977 Knight built what was known as the “Safe House” for athletes to train for Olympics. Over the years Nike made several acquisitions (see the table) and endorsed some of the highest paid athletes.
Today Nike (NYSE: NKE) is the biggest manufacturer of sports shoes that caters to a wide variety of athletes, sports apparels and sports equipments.
Source: www.nike.com
Overview of the US Footwear Industry
US footwear industry is mature and fragmented. Based on the Census Bureau’s 2004 US population estimate (293 million people), every US citizen, on an average, purchased 7.4 pairs of shoes in 2004. This was a volume growth of 7.5% to 2.16 billion shoes over the previous year. Interestingly US produced only 35.2 million pairs of shoes that year, which accounted for less than 2.0% of its consumption The chart aptly illustrates the declining manufacturing Source: American Apparel and Footwear Association
base in the US.
The footwear market can be divided into athletic and non-athletic footwear. Each category has its own set of manufacturing companies (with some overlap) and often is sold through distinct retail channels. Nike operates as an athletic footwear company. According to NPD group, a market research and consulting organization, athletic footwear spending increased by 3.0% in 2005 driven by categories such as baseball, soccer and tennis. High-priced running and basketball shoes sold in price ranges above $80 saw double-digit growth in the athletic specialty/sporting goods channel.
Overall, the footwear industry is truly global in nature, with large manufacturers sourcing products from and selling products in different countries and Nike with its operations in 160 countries is a good example. This strategy allows Nike, facing a slow economy in one country, to keep expanding revenues by focusing on selling in the faster-growing economies. In the recently ended quarter, Nike’s international sales grew 13.7% while sales in US increased by a much lower 7.2%. Moreover, its international operations accounted for 47.5% of the total revenues whereas the US operation contributed 40% (the remaining 12.5% was accounted for by the “others” segment.).
Manufacturers of athletic footwear have diversified into related apparel and sporting goods categories as a way of extending their brand’s reach and growing revenues. For example, Reebok International Ltd. (which has now been acquired by Adidas) saw double-digit growth in Reebok-brand apparel sales in the United States over the past three years, compared to the low single digit domestic growth of Reebok-brand footwear sales. Nike’s newly entered into category “Equipment” has also surpassed the growth in other categories.
According to Sporting Goods Manufacturers Association (SGMA), the combined sales of athletic footwear, sporting goods equipment and sports apparel increased by 6.8% to $55.7 billion in 2005 compared to 2004. SGMA projects a 7.0% increase in sales in 2006. Overall, sales of these items had been generally flat for several years because of the weak economy, stalled participation rates in many sports. The renewed popularity in sports brands for both fashion and performance was largely responsible for the surge in sales in 2005. Wholesale shipments of both, sports apparel and athletic footwear, increased by 9.0% to $26.1 billion and $10.9 billion respectively in 2005 compared to 2004.
Competition
Performance and reliability, new
product development, price and
product differentiation through marketing and promotions are
important aspects of competition.
Nike is the market leader and faces competition mainly from Adidas, a
German company, which recently Source: Annual reports
acquired Reebok International
Ltd. (RBK), another main competitor. The acquisition significantly broadened Adidas’ product line and increased its geographical reach. RBK has a strong presence in the US market with NFL and NBA, which will complement Adidas’ strengths in the European Soccer Champions League.
Also, another German company, Puma, recently reported strong increase in sales, especially in US market. Puma, although a smaller company, is challenging Nike in the apparel segment, which is more “retro” and casual oriented. Apart from these, Nike continues to face intense competition from low-cost alternative footwear manufacturers.
Another smaller, privately held US company New Balance is known for its quality and the “Made in the USA” tag helps the company keep its customer base high. Unlike Nike it concentrates more on the elite customers filing in special orders for custom made shoes. Manufacturing domestically gives New Balance a superior quality of producing premier running shoes. However, Nike has been dominating the industry so far with an estimated 47% market share. Let us do a SWOT analysis of Nike to understand the competitive advantages the company enjoys.
SWOT Analysis:
Strengths
The brand name plays an important role when it comes to Nike. The swoosh symbol marks the best quality.
Nike’s position in the today’s competitive market is due to its product positioning.
Nike is known for producing performance based products that involve new designs and innovations.
It offers a wide variety of products to choose from.
A strong research and development team
Weaknesses
After the retirement of Phil Knight, founder of NKE, from the post of its chief-executive officer (CEO), the company has struggled to find an equally capable leader. This is evident from the resignation of its newly appointed CEO, William Perez over disagreements with Mr. Knight, who is currently the chairman of NKE.
Opportunities
The company has opportunities to explore in the various fields such as producing sporty eye wear, fashion jewelry, casual sporty wear etc.
There is an increasing demand in emerging markets such as China and India, which are producing a generation of rich consumers ready to indulge in brands.
Threats
The acquisition of Reebok by Adidas could significantly increase competition for Nike.
The unorganized sector of footwear and apparel industry is a potential threat for Nike as it offers products at lower prices.
Macro Economic factors
Key Economic Indicators (latest data available)
Real GDP growth rate (2005)
3.5%
Real GDP growth rate (April, 2006)
5.3%
Inflation (April, 2006)
3.5%
Fed Rate
5.0%
Prime Lending Rate
8.0%
Unemployment rate
4.7%
Consumer Confidence Index
109.6 (Highest since May 2002)
According to the Bureau of Economic Analysis, the US’ real gross domestic product
(GDP) increased 3.5% in 2005, down from the rate of 4.2% that was achieved in 2004 but up from a 3.0% increase in 2003. According to the latest data available, Real consumer spending increased 0.1 percent in February 2006 after increasing 0.3
percent in January 2006. These were fuelled by a 0.3% and a 0.7% increase in personal income respectively in the said months.
According to the preliminary estimates Source: Bureau of Economic Analysis
released by Bureau of Economic Analysis, real GDP increased at the rate of 5.3% in the first quarter of 2006. This was driven by increased consumption expenditures.
Consumer Price Index (CPI) rose 0.6 percent in April, 2006 compared to a 0.4 percent rise in March, 2006 as reported by the labor department. Overall consumer prices were up 3.5% in April 2006 compared to April 2005. This was primarily led by higher gasoline prices. However, the core-CPI, which excludes food and energy prices also rose 0.3 percent in April 2006.
In order to control the rising inflation, Federal Reserve’s newly appointed Chairman Ben Bernanke raised the Fed rate by 25 basis points to 5%. It marked the 16th increase of that size since the Fed began to tighten credit in June 2004. In response of the latest increase, commercial banks raised their prime lending rate to 8%. Increases in interest rates have a negative impact on consumers’ purchasing power, because the credit cards payments also increase in tandem. Federal Reserve is expected to further increase the Fed rate at its next meeting in late June, 2006.
Pivotal to a healthy domestic economy is the employment picture, which has been modestly improving since February 2005. The unemployment rate stood at 4.7% in March, 2006 compared to a much higher 5.4% in February 2005. Also encouraging is the fact that average hourly wages increased by 3.8% in April 2006 over the last 12 months while increase in consumer prices trailed at 3.5% over the same period.
Consumer confidence is one of the foundations of consumer spending and, therefore, is of great importance to the apparel industry. It is encouraging to learn that this index has also been improving for the last few months. The Conference Board Consumer Confidence Index improved further in April 2006 to 109.6 after having improved in March, 2006 to 107.5. This is the highest level of consumer confidence since May 2002.
Recent Developments
Latest Financial Performance
Q3 FY06
Q3 FY05
Q3 FY04
Sales growth
9.2%
13.9%
20.9%
Net income growth
19.2%
36.5%
60.6%
Gross margin
43.57%
44.09%
42.07%
Operating margin
13.49%
12.78%
11.36%
Net profit margin
9.01%
8.26%
6.89%
Debt-equity ratio
6.57%
12.74%
15.35%
ROA
14.80%
13.49%
11.67%
ROE
22.50%
21.50%
19.43%
Nike showed an increase in its revenue by 9.2% to $3.61 billion in Q3 FY05 because of strong demands globally and new products. The company’s international market accounted for 47.5% of revenue. The gross margin decreased in the Q3 FY05 by 74 basis points. This was a result of higher input costs such as energy and higher discounts in Europe and Asia. Operating margin shows an expansion by 71 Source: Annual reports
basis points due to the company’s continued focus on controlling operating expenses. It reported a 19.2% increase in its net income in Q3 FY05. Nike ended the quarter with cash and equivalents balance of $2.01 billion. An increase in retained earnings resulted in the increase in shareholder’s equity by 15.4% in Q3 FY05 compared to Q3 FY04.
In Q3 FY05, Nike bought back 1.49 million shares for about $128.00 million under its four-year share repurchase authorization for $1.50 billion, which was approved in June 2004. At the end of Q3 FY05, the company had an unutilized balance of $398.00 million remaining under the program, which will expire in FY07. The company’s goal is to use the program to at least offset the dilution due to employee options, and expects that it would continue to fund the program from its operating cash flow.
On January 23, 2006, Nike’s chief-executive officer (CEO) William Perez resigned from his post following disagreements with founder and Chairman Philip Knight over how to lead the company. Mr. Perez was named CEO after Philip Knight retired from this post last year. Nike’s board appointed Mark Parker as its new CEO on the same day.
On April 18, 2006, Mindy Grossman, head of Nike’s global apparel division resigned from his post to become chief executive of retailing at the New York-based InterActive Corp. Mr. Grossman was credited with revitalizing Nike’s apparel business and bringing the brand closer to women.
