Nike Stock: Near-Term Risks Overshadow Long-Term Catalysts

Investment Thesis

Nike (NYSE:NKE) had a phenomenal quarter, and I say phenomenal simply because it delivered decent numbers despite what was a turbulent market environment. And the future looks bright for the company as a result of the tremendous progress it’s making in the Digital marketplace as well as in the Metaverse. However, in this article, I highlight why I am neutral on the stock in the short-to-medium term due to a combination of challenging market environment and a limited upside from a valuation standpoint.

Digital Marketplace and Metaverse Investments: Catalysts for Future Growth

Let me start by focusing on Nike’s positives. First, the company’s digital drive is gaining a lot of momentum. Nike Digital, its digital marketplace, is proving to be an effective catalyst for growth. It is the company’s fastest-growing revenue driver and now represents 26% of the company’s brand revenue. In the recently concluded quarter (Q3) alone, revenue from Digital was up 22% on a currency-neutral basis, with the segment also witnessing significant improvement in conversion rates and lower customer returns.

The surge in conversion rates on Nike Digital can be primarily attributed to the company’s consumer engagement strategy. For instance, Nike’s digital app, SNKRS, which allows sneaker lovers to stay up to date with new releases, has been a tremendous success. The app’s audience has quadrupled ever since the company began live streaming its product launches last fiscal year. In addition to SNKRS, the company has also utilized Snapchat’s Try On Lens and a partnership with Fortnite to enhance consumer engagement. All these various initiatives of consumer engagement are paying off, which makes Nike Digital a solid catalyst for future growth.

Then there’s the company’s Metaverse push. Nike’s virtual world, NIKELAND, built on Roblox, has seen visits from over 6.7 million players from 224 countries till date. During the NBA All-Star week last month, the company had none other than LeBron James coaching and engaging with the players on the NIKELAND court. Furthermore, in Q3, Nike’s recent acquisition RTFKT, released the first official Nike-branded NFT, which is set to create more inroads in the world of digital product creation. More recently, as part of the company’s “Air Max Day” celebrations (an annual festival to celebrate the company’s iconic Air Max sneaker), the company invited kids to create a digital world with an Air Max theme. “Airtopia,” as the digital world is called, is not only an example of the inroads the company is trying to make in the Metaverse but is also yet another strong example of consumer engagement, especially since they launched this invitation on the back of the release of the first Air Max show for kids.

The global Metaverse market size is predicted to hit $678.8 billion by 2030, according to Grand View Research Inc., growing at a CAGR of 39.4%. The retail industry stands to gain a lot from the digital universe given the opportunities and every major brand has already started planning for it. However, the moves made by Nike so far suggest that it has all the right ingredients to dominate this market in the future.

The Future May Look Bright but Too Many Landmines Today

Now onto the reasons that dampens my excitement for Nike. While supply chain issues are slowly easing off, with factories in Vietnam resuming their operations completely and with nearly all the company’s supplier base resuming their operations without restrictions, transit times continue to remain elevated. The management, during the recently concluded earnings call reported that transit times were now more than 6 weeks longer than pre-pandemic levels and 2 weeks longer compared to the same period last year. Inventories as a result of these long transit times, jumped 22% year over year, with transit inventory now accounting for 65% of the total. While these figures are significantly better than its peer Lululemon Athletica (LULU), this is still a major risk for the company at least in the near term and it offsets the positive news coming in from Vietnam.

Secondly, there is inflation, which continues to be as rampant as ever. While the company did phenomenally well navigating the inflationary pressures in North America, with Q3 sales in the region jumping 9% year-over-year, it is extremely difficult to bet on a scenario where the company repeats this feat in the coming quarters. The management has already highlighted how Q4 is likely to see a negative impact from inflation as a consequence of the low single-digit price increase implemented on its products. With inflation likely to stick around for a lot longer than initially predicted especially with the Ukraine-Russia war acting as a new catalyst, in the short-to-medium term, things are looking pricey for Nike.

Finally, there’s the China problem. Sales declined 8% on a currency-neutral basis and EBIT declined 19% during Q3 of FY22. While the management did suggest that Q3 saw a sequential improvement, the consequences of the stringent COVID-related lockdowns in the region are yet to be fully understood. China has been a major issue for the company in recent times and with COVID lockdowns reaching major cities in the region, it is hard to see sales growing substantially in the region anytime soon.

Nike Stock Valuation

Nike expects FY22 sales to be in the mid-single digits. Therefore, I assume a sales growth of 5% for FY22, which translates to $47.2 billion. Given the multitude of risk factors, which I outlined in the previous section, I assume a modest 7.5% sales growth for FY23, which translates to approximately $50.75 billion. Using the current number of shares outstanding of 1.58 billion (Source: Refinitiv), it would result in a sales per share of $32.12. The company’s historical median forward P/S according to Refinitiv is 4.5x. If I apply this multiple to the sales per share, this would result in a price target of $144.50, which represents an upside of only 4.3% to the closing price on 30th March 2022.

Therefore, while the long-term prospects of the company look fantastic, from an investing standpoint, current levels are not ideal to initiate a fresh position in the stock.

Concluding Thoughts

Overall, I like Nike. The company has evolved with the times and has adapted brilliantly to the ever-changing climate. Its focus on the digital marketplace combined with the significant inroads it has made when it comes to Metaverse are strong catalysts for future growth.

Having said that, in the short-to-medium term, I am not sure whether current levels are a good entry point for long-term investors, given the multitude of risks facing the company. Furthermore, from a valuation standpoint, the company appears to be more or less fairly valued, with a forward price/sales multiple yielding a price target of $144.50, which represents an upside of just 4.3% to the closing price on 30th March 2022.

However, any further pullback and/or a fundamental change in the market environment should encourage investors to just do it, the “it” being initiate a position in this retail giant.