Despite a few solid bullish runs, 2021 is shaping up to be an underperforming year for NIKE, Inc. (NYSE: NKE).
Yet, regardless of its below-average volatility, the earnings report has significantly pushed the stock for the third consecutive time.
- GAAP EPS: US$0.83 (beat by US$0.21)
- Revenue: US$11.36b (beat by US$110m)
- Revenue growth: +1.1% Y/Y
- Direct sales: US$4.7b
- North American digital sales growth: +40%
- Gross margin: 45.9% (+280 b.p)
While the company beat expectations, revenue growth at 1.1% is sluggish at best, likely impacted by the worldwide supply challenges. Fiscal 2022 revenue growth is expected to stay within the low-single digits, with the product costs rising in the second half.
On a positive note, digital sales growth in the domestic market showed the ongoing transformation to digital. Meanwhile, Nike acquired RTFKT – an NFT studio that focuses on virtual sneakers and collectibles. This is signaling a further push in the digital direction.
Calculating the Intrinsic Value
Companies can be valued in many ways, so we would point out that a Discounted Cash Flow (DCF) is not perfect for every situation. If you still have questions about this type of valuation, look at the Simply Wall St analysis model.
We use what is known as a 2-stage model, which means we have two different periods of growth rates for the company's cash flows. Generally, the first stage is higher growth, and the second stage is a lower growth phase.
In the first stage, we need to estimate the cash flows to the business over the next ten years. Where possible, we use analyst estimates, but when these aren't available, we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage and that companies with growing free cash flow will see their growth rate slow over this period.
A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we need to discount the sum of these future cash flows to arrive at a present value estimate:
10-year free cash flow (FCF) estimate
|Levered FCF ($, Millions)||US$5.40b||US$6.53b||US$7.80b||US$8.60b||US$9.68b||US$10.5b||US$11.1b||US$11.7b||US$12.2b||US$12.6b|
|Growth Rate Estimate Source||Analyst x11||Analyst x10||Analyst x7||Analyst x3||Analyst x3||Est @ 8.23%||Est @ 6.35%||Est @ 5.03%||Est @ 4.11%||Est @ 3.47%|
|Present Value ($, Millions) Discounted @ 6.6%||US$5.1k||US$5.7k||US$6.4k||US$6.6k||US$7.0k||US$7.1k||US$7.1k||US$7.0k||US$6.8k||US$6.6k|
("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$66b
After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. For a number of reasons, a very conservative growth rate is used that cannot exceed that of a country's GDP growth.
In this case, we have used the 5-year average of the 10-year government bond yield (2.0%) to estimate future growth. In the same way, as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 6.6%.
Terminal Value (TV)= FCF2031 × (1 + g) ÷ (r – g) = US$13b× (1 + 2.0%) ÷ (6.6%– 2.0%) = US$274b
Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$274b÷ ( 1 + 6.6%)10= US$144b
The total value is the sum of cash flows for the next ten years plus the discounted terminal value, which results in the Total Equity Value, which in this case is US$210b. We divide the equity value by the number of shares outstanding in the final step. Compared to the current share price of US$157, the company appears around fair value at the time of writing. Remember, though, that this is just an approximate valuation.
We would point out that the most important inputs to a discounted cash flow are the discount rate and, of course, the actual cash flows. The DCF also does not consider the possible cyclicality of an industry or a company's future capital requirements, so it does not give a complete picture of its potential performance. Given that we are looking at NIKE as potential shareholders, the cost of equity is used as the discount rate rather than the cost of capital (or the weighted average cost of capital, WACC), which accounts for debt.
We've used 6.6% in this calculation, which is based on a levered beta of 1.070. Beta is a measure of a stock's volatility compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, a reasonable range for a stable business.
Despite the iconic brand strength, the current valuation of Nike is hard to justify, even after correcting down from the peak. At this point, low single-digit growth is barely offsetting the inflation. Nike remains on the "no man's land." A company with good margins, a great balance sheet, high ROE, but with limited growth prospects and expensive valuation. While digitalization is starting to pay off, it might simply not be enough of a catalyst for the company with a market cap of 1/4 trillion.
Although the valuation of a company is important, it ideally won't be the sole piece of analysis you scrutinize for a company. DCF models are not the be-all and end-all of investment valuation. Preferably you'd apply different cases and assumptions and see how they would impact its valuation. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. For NIKE, there are three further aspects you should further examine:
- Financial Health: Does NKE have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Future Earnings: How does NKE's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.
- Other High-Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high-quality stocks to get an idea of what else is out there you may be missing!
PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.
Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.