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The Pullback in Nike Looks Like a Buying Opportunity

By Markets Fool.com

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Image source: Motley Fool.

Nike (NYSE: NKE) stock has been under considerable selling pressure lately. Shares of the sports clothing leader are down by more than 20% in the last year, mostly due to concerns about decelerating growth in the company's future orders. However, the market seems to be missing the big picture when it comes to Nike, and there are reasons to believe that the recent pullback in the stock could be creating a buying opportunity for long-term investors.

Investors are focusing on the wrong metric

Performance during the quarter ended in September, which is the first quarter of fiscal 2017 for Nike, was quite solid. Revenue grew 8% year over year, while sales in constant currency terms increased 10%. This is actually an acceleration versus a 6% increase in U.S. dollar revenue and a 9% jump in constant currency sales growth during the quarter ended in March.

Constant currency sales for the Nike brand increased by double-digit percentages across all international markets, and China is looking like a particularly strong driver for the business. Constant currency sales in the Greater China region increased 21% during the quarter, and management highlighted the fact that China is now the largest retail market in the world after surpassing the U.S., so growth opportunities look quite exciting in that key region.

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The main reason for disappointment is that future orders are slowing down. Nike ended the quarter with $12.3 billion in future orders for delivery from September 2016 through January 2017. This is a modest increase of 5% in U.S. dollars and a 7% growth rate in constant currency terms.

At first sight, slowing future orders seem to be indicating that revenue growth is decelerating. However, it's important to note that future orders are losing relevanceas a forward-looking indicator for Nike. That's because the company has aggressively expanded into the direct-to-consumer segment over the past several years by opening more of its own stores and broadening its online presence. This means that Nike doesn't need to liquidate inventory via future orders to the same degree, since it can sell that inventory directly to consumers.

This is evident in the words of Nike's CFO, Andy Campion: "The relationship between reported futures and reported revenue in a given quarter has become less correlated based on our evolving business mix." For this reason, Nike has decided to disclose future orders information in a broader context going forward, as opposed to using the indicator as a stand-alone forward-looking metric in its earnings reports.

Direct-to-consumer revenue grew 22% last quarter, while online sales increased 49% year over year, and Campion believes that growth in North America will outperform future orders growth over the coming quarters: "We expect North America's reported revenue growth over the balance of the year to outpace the rate of futures growth, driven by stronger sell-through to consumers."

Nike is still performing quite well in different markets, and decelerating growth in future orders doesn't look like such a big problem considering that the company is compensating it with vigorous growth in the direct-to-consumer segment. In this light, Nike seems to be doing much better than what recent price performance could indicate.

A fair price

Even after the recent pullback, Nike stock is still trading at a modest premium versus the overall market. The company carries a price-to-earnings ratio of 23.3, while the average company in the S&P 500 is trading at a price-to-earnings ratio around 19.6.

However, strong brands in the sports clothing segment typically carry above-average valuations, so Nike is not necessarily overpriced at these levels. In fact, the average price-to-earnings ratio for Nike over the past five years is 24.7, so the company is even trading at a small discount by its own historical standards.

Offering a similar perspective, competitors such as Adidas (NASDAQOTH: ADDYY), Under Armour (NYSE: UA), and lululemon athletica (NASDAQ: LULU) trade at higher valuations than Nike. The following table compares several valuation ratios such as price-to-earnings, price-to-free-cash-flow, and enterprise-value-to-EBITDA for the four sports clothing retailers. By these metrics, Nike looks attractively valued in comparison to its peers.

Company Market Cap P/E P/FCF EV/EBITDA
Nike $86.95 billion 23.3 27 16.7
Adidas $35.8 billion 34.7 30.8 18.7
Under Armour $15.7 billion 39.2 N/A 33.2
Lululemon $8.17 billion 30 22 16.9

Data sources: Yahoo! Finance and Morningstar.

Adidas, Under Armour, and Lululemon are considerably smaller than Nike, and this could mean superior potential for growth over the years, since it's relatively easier to sustain rapid growth from a smaller revenue base. However, even if smaller competitors could deserve a higher valuation, the main point to consider is that Nike is still fairly reasonably priced on a relative basis.

Investors seem to be overreacting to decelerating growth in Nike's future orders because the indicator is arguably not as representative as it was in the past. The business continues performing well across the board, and the stock is valued at fairly reasonable levels. For these reasons, the pullback in Nike stock looks like an opportunity to purchase a high-quality business on short-term weakness.

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Andrs Cardenal has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Lululemon Athletica, Nike, and Under Armour (A Shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.