For Nike, the Other Shoe Is About to Drop

 | Aug 31, 2017 | 11:30 AM EDT
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Nike (NKE) is up less than 4% year to date, and for sure investors are wondering: Can this company, named after the Greek goddess of victory, win again or has time passed it by? I think Nike still has a way to go down. By my estimation, the company is worth $40 per share.

In the most recent 12-month period, Nike is down more than 9%, but Wall Street remains optimistic on the company's prospects. Telsey Advisory Group is holding out hope and a $61 price target, while the guys at Morgan Stanley recently upgraded the stock; they are praying for $68 a share.

Meanwhile, Nike's largest retailer, Footlocker (FL) has been kicked to the curb. Year to date, the shares are down 50%. Two weeks ago, Footlocker said same store sales were down 6% versus low single digit guidance. Revenue fell 4.4% to $1.7 billion versus the previous guidance of $1.8 billion. Gross margin fell to 29.6% from 33% in the year earlier period.

If that wasn't enough, management said they expect comparable sales to be down 3% to 4% over the remainder of the year. At its most recent analyst meeting, Footlocker said Nike accounts for 67% of its total sales.

Oh, and how about Finish Line (FINL) ? Finish Line pre-announced second-quarter results of $469.4 million versus the $477 million expected while forecasting earnings between $0.08 and $0.12 versus the $0.38 estimate. The company lowered its comparable sales guidance from an increase in the low single digits to a decline of 3-5%. Furthermore, Finish Line slashed its earnings guidance from previous guidance of $1.12-$1.23 to $0.50-$0.60 per share. The stock fell 29% on the news.

The athletic footwear industry has been hit by a variety of negative trends, including oversupply, lack of excitement -- especially in basketball -- inventory liquidation from widespread store closures and a high level of promotional activity. While Adidas (ADDYY) sales have been strong, it's clearly not enough to offset the disaster that is going on at Nike.

Besides the lack of innovation in the footwear business, Nike seems more interested in selling directly to consumers. In fact, ecommerce sales have been on fire. In fiscal 2016, direct-to-consumer sales rose 25% and last year sales increased 18%, while the wholesale business grew just 5%. The wholesale business was 74% of total sales last year.

Nike continues to have problems with excess inventory. While inventory fell 6% in North America, that wasn't enough to bring it in line with the company's goals. On top of that, international inventory jumped nearly 15% in fiscal 2017.

I would avoid the whole athletic footwear group. The stores are too dependent on Nike, innovation in footwear design is clearly stalled, and inventory keeps piling up.

In fact, I think Nike is a $40 stock. Operating margins are flat. Nike reported year-end operating margins of 13.8%, but most forecasts are looking for operating margins to come in at 13.6%, which is not enough to drive the stock higher.

The company is in the middle of a $12 billion share buyback plan, but that only sops up enough shares to boost earnings by about $0.40 between 2017 and 2018. At $60 a share, the stock would be trading around 24 times fiscal 2018 estimates, which is a pretty steep premium to the footwear group and especially the retailers that Nike is supporting.

In my mind, Nike shares should trade in the mid teens, or about 15-17 times forward estimates, which puts the stock in the $40s. Analysts think revenue will grow in the mid single digits this year (FY18) and earnings are likely to be down 4-5%. How is that worth 24 times estimates?

I think the other shoe is about to drop on Nike and the stock is going lower, as investors realize that time has passed this Greek goddess by.

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