Investment thesis
Nike (NYSE:NKE) needs no introduction since it is one of the most famous companies in the world. Its competitive advantage is significant, but that doesn't mean the company can't be overvalued. Being one of the world's best-known brands is not enough to make it worth investing in.
As we can see from this chart, Nike's stock price has always had an increasing and constant trend, at least until 2019. From 2020 onwards due to the pandemic there was a general collapse of the entire stock market which also hit Nike hard ($60 per share in March 2020). Since then, there has been a large influx of capital that has pushed Nike to $180 in about a year and a half. This is a 70% increase from pre-Covid-19 levels.
Personally, I believe this sharp rise was mainly triggered by general market euphoria and not by the improvement of the underlying business, so I consider Nike overvalued. My thesis will be confirmed by using a discounted cash flow and making a simple comparison of valuation multiples. My opinion on Nike is a strong sell, which may turn into a buy once it reaches $70-75 per share. The recent 35% drop is not enough.
What is Nike's fair value?
As already mentioned, the valuation of Nike will be carried out through a DCF and the method of multiples. Both these methods are based exclusively on numerical values; therefore, they do not take into consideration other exogenous variables, whether positive or negative.
Discounted cash flow
The discounted cash flow method is one of the most widely used in finance and consists of discounting the value of the company's future cash flows in the present. Since some of the values included in this model are based on my assumptions, I will consider three different scenarios in order to consider three different views: I will try to limit subjectivity. Before starting with the construction of the models however it is well to clarify what will be the free cash flow inserted in the first year. It will be from there that I will begin to calculate the free cash flow of future years and therefore the entire model is based on this value.
From what we can see, Nike's free cash flow looks rather discontinuous but growing over the long term: from 2017 to date it grew at a CAGR of 8.41%. If we consider from 2018 to date the CAGR would drop to only 2.99%. Within the three models I will purposely be unconservative and consider at year 1 the highest figure ever recorded for Nike, $5.8 billion. The values of net debt and shares outstanding belong to TIKR Terminal and will be the same in the three models considered.
Best-case scenario
In the best-case scenario, Nike is undervalued as its fair value is $132.32. However, using a 20% margin of safety, it is not worth buying Nike at the current price. In this scenario I have used a growth rate of 10%, which is much higher than what I have seen in the past. In addition, I have considered a risk-free rate of 3% in the WACC calculation, which means that I am assuming that interest rates will not rise in the future and have peaked. Considering recent inflation levels, tight monetary policy, and supply chain issues, I consider this scenario far too positive.
Normal scenario
In this scenario, which I consider the most likely, Nike is overvalued by 30% since its fair value is $83.68. With a margin of safety we are far from the current price. In this scenario in the calculation of the WACC I have considered a risk-free rate of 3.5%, a beta of 1.21 (the previous one was 1.05) and an addition of 0.25% due to possible unforeseen risks (in the previous scenario it was 0.13%). Finally, I reduced the free cash flow growth rate to 7% (it's always a higher growth rate than the last 5 years). These assumptions do not seem so far-fetched at all, yet Nike is very overvalued.
Worst-case scenario
In the worst-case scenario, Nike's fair value is $56.94, therefore a much lower value than the current one. Within this scenario, I have made only two changes from the previous model: the free risk rate has increased to 4% and free cash flow growth has decreased to 3%. While this fair value may seem too low, I personally don't think it's that unlikely. The US ten-year bond went from 1.5% in January 2022 to the current 3% in about 5 months: is it so absurd to think that it could reach 4% considering the current inflation rate of over 8%?
As far as the growth of free cash flow is concerned, I have simply used the same as in the last five years. Is it so absurd to believe that free cash flow can grow by 3% also in the future considering the current supply chain problems? And finally, it should also be considered that I used as starting free cash flow the highest one ever achieved by Nike.
Method of multiples
Considering the price multiples, again Nike is very overvalued since its multiples are far higher than those of its competitors in the same sector. It must be said, however, that I do not agree with the overall grade that has been given to Nike. It is true that the multiples of its competitors are much lower, but historically Nike has always had higher multiples: if you want to buy a good company you must pay more.
I consider the current P/E of 31.30 excessive given Nike's future growth, but at the same time a P/E of 12.65 equal to the sector average is excessively low. By averaging these two values, Nike's P/E would be 22, a more reasonable value in my opinion. Considering that the estimated annual EPS for this year is $3.75, with a P/E of 22 Nike's fair value would be $82.50.
Average fair value
By averaging the valuation methods used, Nike's fair value is $94.68, which is quite far from the current $118. Within the calculation, I have also included Nike's current value since I consider it as the value that the market currently gives to Nike. No margin of safety has been considered in this final calculation. If this fair value seems absurd to you, I remind you that in March 2020, Nike collapsed to $60 and about 6 months ago, it was trading at $180. Personally, I would consider an initial buy if Nike reached $70-75 per share.
This article was written by
Eugenio Catone
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Passionate about financial markets, I express my opinion on Seeking Alpha about the economy in general and individual companies.
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