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Pricey Nike can’t keep beating the market

If investing is a marathon and not a sprint, Nike Inc. stock might just be a buy. Investors interested in the dash to the top 2014 returns, however, may find the shares of the shoemaker have little room to run.

Why the distinction? Well, Nike is, by nearly all accounts, the strongest, most global brand in athletic apparel – a company with a strong balance sheet and growing sales in all corners of the world.

That helped the shares rise more than 50 per cent in 2013, even including a mixed quarterly report in December that put only a small dent in its share price. At well over 20 times earnings, depending on which part of the calendar you measure, the stock is trading at levels above its normal premium to the market.

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That leads some analysts to say that as much as they admire the company, it's hard to see the stock easily lapping the broader market this year, as it has so many times before.

Certainly, the company and its iconic brand is a leader in a leading industry: "Activewear" is easily outpacing sales of conventional clothing, to the tune of an average 18 percentage points over the past five years, say analysts at Canaccord Genuity. They cite "persistent innovation by athletic companies vs. little to no innovation from traditional apparel companies," as well as increasing fashion focus by the athletic brands and a growing embrace of active lifestyles.

(Or, as analyst Faye Landes of Cowen Securities humorously notes, "For reasons that remain somewhat unclear to us, in 2013 it suddenly became acceptable to wear activewear in virtually every imaginable venue, including some offices. Whether it's the ongoing sloppification of America, the introduction of ever more comfortable fabrics, peer pressure to look like you care about working out, or simply a fashion shift, dress codes have shifted very rapidly.")

It is Nike that benefits most. Nike is the first choice for athletic apparel for 42 per cent of the U.S. population, a figure that is well ahead of any other brand and rising. Cowen's brand survey found Nike's "cool factor" is highest among adults ages 18 to 24 and is significantly higher among non-whites than whites, both of which bode "extremely well for Nike long-term." Even better, perhaps, is that although Nike has been raising prices, 42 per cent of consumers in the Cowen survey "agree" or "strongly agree" that Nike's products are fairly priced – up seven percentage points from a year before.

It's obviously not just a U.S. story, however. Chinese same-store sales growth – a measure of revenue gains in locations open a year or more – has exceeded 20 per cent for three quarters in a row, says S&P Capital IQ analyst Jason Asaeda. "We think Nike's focus on meeting the needs of more discerning and sophisticated Chinese consumers is starting to gain traction," says Mr. Asaeda, who has a "buy" rating and an $86 (U.S.) target price, 11 per cent above current levels. (The company pays a dividend that yields 1.2 per cent.)

The problem with all this good stuff about Nike is the earnings multiple that investors are putting on it. Mr. Asaeda's target price is 25.7 times his calendar 2014 earnings-per-share estimate, above the top end of the 10-year historical P/E range. At current prices, Nike trades at about 24 times forward earnings, according to Capital IQ.

Going into Nike's Dec. 19 earnings report, Canaccord Genuity's Camilo Lyon said the company needed a "meaningful beat" of analyst expectations on sales or earnings to drive its shares higher. That is not what Nike delivered, as it exceeded earnings expectations by a penny per share.

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While there were plenty of positives, such as strong growth in orders to be shipped in coming months, there were warning signs. The company's expenses are accelerating, Mr. Lyon noted while analyzing the results, as it markets more in advance of the World Cup, and the prices of raw materials are increasing. In addition, the rising U.S. dollar isn't helping Nike's results, as every international sale is worth less and less in the company's home currency.

The company's guidance for the second half of its fiscal year, which ends May 31, implies "a meaningful reduction" in earnings in the next two quarters compared with his prior expectations. His estimate for fiscal 2015, starting in June, is for $3.21 in earnings per share, below the consensus of $3.50.

His earnings forecast still represents a 12-per-cent gain in EPS from his current-year estimate, but he questions whether that justifies the current premium multiple, as he has a "hold" rating and $71 target price. "We prefer to play [Nike's] strength through its retail partners, Foot Locker and Finish Line," he said. (The two athletic-wear retailers trade at 13.5 times and 15.9 times forward earnings, respectively, according to Capital IQ.)

Nike's rich valuation has neatly split the analysts who follow it; 16 have "buys," with 14 rating the stock a "hold." The average 12-month target price, according to Bloomberg, is $81.86, a return of just 6 per cent. In the race that is the 2014 equity market, there's a fairly good chance it won't be Nike setting the pace.

By the numbers

  • Revenue (past 12 months): $26.3-billion
  • Net income (past 12 months): $2.49-billion
  • Market capitalization: $68.3-billion
  • Forward P/E: 23.9

All dollar figures U.S. Source: S&P Capital IQ

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About the Author
Business and investing reporter and columnist

A business journalist since 1994, David Milstead began writing for The Globe and Mail in 2009. During eight years at the Rocky Mountain News in Denver, Colo., he individually or jointly won nine national awards from SABEW, the Society of American Business Editors and Writers. He has also worked at the Wall Street Journal. More


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