At what point does Nike’s dramatic decline become an irresistible bet for contrarian investors? Perhaps not too far from here. The sportswear giant is arguably one of the most reviled names in the market today, facing removal from the S&P 100 next week and open mockery across social media.
The interesting part of the debacle is that much of it was self-inflicted. A few years ago, with Apple’s model somewhere in mind, Nike embarked on what was then a widely acclaimed strategy: build out its direct-to-consumer channels, bypass retailers, and capture more of the economics for itself.
It turns out people do not buy sneakers quite the way they buy phones. With the latter, they know exactly which device they want; the purchase merely closes the gap. With the former, no particular model occupies their dreams. What they do instead is stroll the aisles and let themselves be seduced by whatever flashy release catches their eye.
By going all-in on DTC and neglecting longstanding relationships with wholesalers, Nike left valuable shelf space open to competitors. Look no further than the rise of Hoka, On, Asics, Adidas, New Balance and others. Nature abhors a vacuum, and rivals were only too happy to fill this one with their own wares.
The encouraging part is that the problem looks solvable. None of these brands can match Nike’s marketing firepower, breadth of offering or reach. The Swoosh can, and will, reclaim at least some of the ground it surrendered. The comeback, however, has a name and a cost: rebates. Those will weigh on margins for at least eighteen months, a horizon few investors seem willing to sit through.
Another charge, levelled with particular relish on social media, is that Nike succumbed to the “woke virus” and in doing so alienated too many of its customers. This is largely hogwash. One of the outstanding features of Nike’s brand has always been its extraordinary breadth of appeal, from kids in the projects to suburban grandmothers.
Nike has long been universal, and very few consumer names can claim as much. Together with its grip on nearly every top athlete across nearly every sport, that remains its most formidable asset.
There is plenty else on the charge sheet: inept share buybacks conducted at elevated valuations, lacklustre product innovation, lost ground in China, and unwarranted stock-based compensation. All are legitimate concerns. None, however, looks obviously fatal, and each can be addressed with time and competent execution.
Consider the numbers for a moment. Nike has historically been a slow and steady grower: revenue increased roughly five-fold over three decades, while operating earnings compounded at a somewhat faster pace. It has also been a well-capitalised dividend aristocrat, regularly producing returns on equity of around 25% without relying on leverage.
Now suppose growth becomes a thing of the past. Suppose that, despite its push to reclaim shelf space, Nike plateaus at $50bn of annual revenue for the foreseeable future. Assume further that net margins merely recover to their two-decade average of around 8%. That would produce roughly $4bn of bottom-line earnings, all of it available for distribution to shareholders
For another layer of conservatism, grant that the company never reduces its share count again, despite that being a departure from its longstanding capital-allocation policy. We can then weigh that $4bn of normalized earning power against Nike’s current market value of roughly $54bn.
The assumptions can naturally be moved in either direction. Perhaps the brand really is in lasting decline and continues to lose relevance, though that seems a demanding conclusion from the evidence today. Perhaps, at the other end, Nike eventually resumes its forward march. Or perhaps margins simply recover into double-digit territory, where they have often sat over the past decade.
Is this an exceptional opportunity, akin to Apple selling for eight times earnings, as it did twice, in 2016 and 2018, while it was steamrolling the competition? Certainly not. But is it a decent place to park cash if you’re short of better ideas? Quite possibly.