Nike’s Q3 Earnings Approach: Battleground For Bulls And Bears (NYSE:NKE)

Introduction

Nike (NYSE:NKE) is about to report its Q3 fiscal 2024 earnings. So much different news about the company is being published almost daily, making it a battleground for bulls and bears engaged in a fight that could puzzle more than one investor.

In fact, many are reporting that Nike is facing competitive pressures. Others believe the stock is at a compelling entry point and consider it an industry leader able to withstand the test of time.

Across the industry, the majority of apparel-related stocks have been outperforming YtD, with Abercrombie & Fitch (ANF) jumping up almost 50%. However, an athleisure retailer such as Lululemon (LULU) seemed to suggest decelerating trends in the last earnings report.

Also, Foot Loker’s weak outlook and promotion-based 2023 operations to clear inventory weighed on several names in the sector. Therefore, Nike is still seen as “muddling through a post-pandemic, strategic re-set”, according to Oppenheimer. In addition, Nike is discounting its China exposure if a tariff war heats up.

So, the question arises: is Nike going to swipe away from the table these concerns, or should we expect a report with mixed or weak results? In this article, I will share my take.

Summary of previous coverage

While Nike more than doubled from its March 2020 lows after the pandemic, it has traded down since early 2022 and is now back to its early 2020 levels of around $100. In the past, I have considered this a good entry point for long-term investors.

In fact, its strong franchise, its high ROIC coupled with its undisputable leadership in the industry, and the growing demand for athletic gear because of the casualization of fashion made me see it as a valuable opportunity.

However, I have also shared my thoughts on the fact that, unlike many, I don’t consider Nike to have a strong moat.

It is part of the largest fashion industry. And, though, it has been a leader for several decades, Nike still faces stiff competition and always has to keep innovating to protect its leadership.

As a result, Nike has to spend a lot of money not only on product innovation, but also to establish relationships with professional athletes, sports teams, and other figures to promote its brand and its products. These relationships cost a lot of money (in FY 2023, $4 billion,7.8% of total revenues), but they also make us understand how, for Nike, storytelling is at the heart of the brand.

Surely, Nike is aware of this, and its financial history over the past 10 fiscal years shows the company pays a lot of attention to its balance sheet, to make it bulletproof in case of any economic downturn.

To show what I mean, I made this graph:

As I explained in my past article:

The light blue columns show Nike’s revenues. In 2013 Nike’s top line came in at $25.3 billion. At the end of FY2023, the company had more than doubled it, generating $51.2 billion in revenue. At the same time, the orange line shows Nike’s gross margins, which have always been stable between 43% and 46%. Pretty good performance. Nike’s profitability has always been best-in-class, as the green line shows, highlighting Nike’s return on equity which is trending upwards with the last few years always seeing a result above 30%. Remarkable.

At the same time, the balance sheet has been credit-worthy. Nike currently has LT debt ratings of AA- and A1 from S&P Global Inc. (SPGI) and Moody’s Corporation (MCO). If we look at the yellow and dark blue columns, which respectively show Nike’s cash and LT debt, we see how generally speaking, the company holds as much cash as the LT it carries, derisking the company to a zero-leverage level.

Nike’s Q3 2024 Earnings Preview

This quarterly report will show us how Nike performed during the holiday shopping season. As we have seen, clothing and accessories were among the top categories for gifts. So, even though we have seen some mixed news about the industry, I expect the impact of strong consumer spending will surely be seen on Nike’s financials, given its worldwide popularity.

Consensus revenue estimates on Seeking Alpha expect Nike to report a decline in sales by almost 1% to $12.29 billion. I disagree for two reasons: holiday shopping has been strong; the promotional environment has helped volumes and should not have hurt margins (as we have already seen in Q2).

This is why the foundation of my forecast is an expected revenue growth of 2%-3%. This means Nike should rake in around $12.7 billion in revenues. But a year ago, Nike’s gross margins were still seeing some downward pressure and came in below 44%. Recent quarters have seen Nike’s gross margins come once again above 44%. I do expect this quarter to report a gross margin of 44%, which is equal to $5.59 billion in gross profit.

Demand creation expenses probably increased once again and should be around $1.2 billion. Adding another $3 billion of operating expenses, we have total operating expenses of $4.2 billion. This leads me to expect an operating income of close to $1.4 billion. Since Nike’s net income margin is usually around 10%, we can expect Nike’s bottom line to be close to $1.27 billion.

Considering Nike reported 1.52 billion shares outstanding at the end of the last quarter, we could expect EPS around $0.84 if we assume the number of shares outstanding has decreased to 1.51 billion due to buybacks. This is a Q3 EPS estimate 10% above the current consensus of $0.76. This could imply Nike could post FY 2024 EPS around $3.35, which is close to a 4% growth YoY. In other words, Nike may be trading just below a 30 fwd PE.

Let’s talk about free cash flow, which is an item we can’t just overlook.

Nike has rarely spent more than $1 billion in capex in the past 4 years. On the other hand, it has reported growing operating earnings. I expect that Nike will end this fiscal year with $6.5 billion in operating earnings. This leaves us with around $5.5 billion in expected FCF. As a result, I estimate that Nike will close the year with a FCF per share of $3.64. This is a 3.64% FCF yield which is decent, though not cheap. If we factor in around $800 million in stock-based compensation, the adjusted FCF, the yield comes down to 3.1%.

Clearly, Nike is not trading at a cheap valuation, as Seeking Alpha Quant Valuation Grade shows, awarding Nike an F. But what is actually the issue I see outlining is the lack of strong growth, even though the very first page on Nike’s IR website says Nike “is a growth company”.

Conclusion: Nike Remains a Hold Into Earnings

As strange as it may seem when we deal with an established and worldwide recognized market leader such as Nike, it is difficult to predict a huge earnings beat this time. Even though my estimate for the report is more bullish than the consensus, I am still in the range of a low-single-digit top-line growth, which seems to be too low to justify a 30 PE and a FCF yield of 3%. And yet, I see no signs from Nike’s environment that suggests a bigger growth. As a result, in case Nike does report a significant beat, we could see the stock move accordingly. This could be a challenge to my hold rating.

Some investors looked at DICK’S Sporting Goods (DKS) earnings as a sign of a stronger-than-expected market. However, as I read through the report and the earnings call transcript, the earnings beat can be explained as the result of two factors: expectations were particularly low and Dick’s operations are improving. There was no particular mention of sneakers or sporting goods performing beyond expectations.

Another risk of this earnings report may be linked to Nike’s guidance. If the company discloses weak guidance for the full year, with almost flattish growth, then we may see the stock being re-rated by investors. A similar case, although in another industry, is occurring with Hershey (HSY). The management has guided for no YoY growth and, as a result, the stock has settled around a 20 PE instead of the 25 it trades at, on average.

The outlook is somewhat mixed. As a business in and of itself, I don’t think Nike is particularly endangered. It will be hard to take its leading position. But in terms of an investment with a nice risk/reward ratio, the slowing growth of this huge giant, coupled with a mixed outlook, makes me still consider Nike’s valuation a bit expensive and at risk of seeing a multiple contraction. As a result, I am just holding my shares and I rate the stock as a hold.