Since its founding in sleepy Beaverton, Oregon, in 1964, Nike (NKE) has grown into the world’s most dominant sports apparel supplier, and 18th most valuable brand in the world.

Along the way they have made countless long-term dividend investors very rich. In fact, from 2006 through 2015, Nike has returned 20.9% per year (including dividends) compared to the S&P 500’s 7.4% annual return.

Nike

However, over the past year, concerns over slowing sales, increasing competition from the likes of Adidas (ADDDF) and Under Armour (UA), and falling margins have sent shares nose diving over 20%.

Learn if the king of sports apparel could be unseated from its throne and if this recent sell off makes now a reasonable time to buy what could prove to be one of the best blue chip dividend growth stocks of the next decade.

Business Description

Nike designs, develops, markets, and sells footwear, sports apparel, equipment, and accessories around the world in nine major market segments: basketball, Air Jordan, football, men’s and women’s training, action sports, sportswear, and golf. Some of its key brands are Nike, Jordan, Hurley, and Converse.

It has four main reporting units: Footwear, Apparel, Equipment, and the Global Brands division. However, as you can see, Footwear, and Apparel are by far the largest, fastest growing, and most important divisions.

Division Fiscal Q1 Revenue % of Revenue YoY Change YoY Constant Currency
Footwear $5.472 billion 64.7% 7% 10%
Apparel $2.549 billion 30.1% 9% 12%
Equipment $423 million 5.0% 4% 6%
Global Brands $15 million 0.2% -42% -30%
Total $8.459 billion 100% 8% 10%

Source: Nike Earnings Release

By geography, approximately 47% of Nike’s sales are within the U.S. Around two thirds over Nike’s total revenue is generated by North America and China. The business is very global.

Business Analysis

Barring times of extreme global economic weakness Nike has been able to generally put up annual high-single to low-double digit sales growth, even more impressive EPS growth, and steadily rising returns on investor capital.

Since 2005, Nike’s revenue has more than doubled and EPS has more than tripled.

These are all signs of the company’s strong innovation brand equity, which gives Nike good pricing power and a strong moat. Speaking of innovation, over the past 25 years, Nike has built the third largest design patent portfolio in the country.

Once the company invents a product, it can scale it across sport categories and geographies. As the world’s largest footwear and athletic apparel brand, Nike also enjoys economies of scale in its production processes.

The final result of these strengths can be seen in Nike’s industry leading margins and very impressive return on capital.

Company Operating Margin Net Margin Free Cash Flow Margin Return On Equity Return On Equity Return On Invested Capital
Nike 13.1% 11.6% 6.8% 18.3% 30.6% 27.0%
Industry Average 11.6% 8.9% NA 13.7% 23.6% NA

Source: Morningstar, Simply Safe Dividends

Of course, with the global economic slowdown recent sales growth hasn’t been nearly so good, and a recent increase in inventory, and the commensurate markdowns needed to clear them, has pressured margins somewhat.

However, that hardly seems to justify the market’s overreaction over the past year. That’s because of several key positive factors that Wall Street is currently overlooking.

First, keep in mind that Nike’s brand strength remains as robust as ever, thanks to it having honed athlete endorsements down to a science, as seen with the decade’s long premium pricing power of the Air Jordan brand.

Second, international growth, especially in developing markets, gives the company a very long growth runway. For example, in the last quarter constant currency sales growth in China, Japan, and Emerging Markets came in at 21%, 18%, and 11%, respectively. That’s especially true given that the global sports apparel and footwear industry is estimated to be over $270 billion in size, meaning that Nike’s overall market share is less than 15%.

Third, some of the increase in inventory is due to Nike executing extremely well in its direct-to-consumer, or DTC efforts, especially with sales through Nike.com. For example, DTC and NIKE.com sales in the fiscal Q1 were up 22% and 49%, respectively; far higher than retail sales in any of its international markets. Nike’s e-commerce business is a little over $1 billion and is expected to grow to $7 billion by the end of fiscal year 2020.

Finally, while Nike may not seem like a tech company, it’s in fact adopting the latest in manufacturing technology in order to boost sales, earnings, and margins. For example, online sales allow customers to customize shoes, which sell at premiums compared to what is available in stores.

In addition, management is currently investing heavily in what it calls “ManRev,” or manufacturing revolution, which is expected to further boost the company’s core strengths.

CEO Mark Parker, who started out as a shoe designer, has been with the company for 30 years, and has been in the top job since 2006, points out that through the benefits of further production automation, and 3D printing, the company can reduce waste in product manufacturing, increase how quickly new products can hit the market, and offer customers even more customization.

In other words, via investing in state of the art manufacturing processes, the company can cut costs, maintain or win market share, and boost margins. In fact, Morningstar analyst R.J Hottovy thinks that Nike can boost its gross margins by as much as 310 basis points, or 3.1%, to 49% by 2020 using such techniques.

To put that in perspective, the last year’s margin decline that caused the stock to collapse by nearly a quarter was just 30 basis points. Which means that the market’s reaction to a successful implementation of even better economies of scale, and superior manufacturing methods should be much greater, resulting in potentially amazing capital gains.

Key Risks

There are several important risks to consider when evaluating Nike.

First and most obvious is the growing competition from upstarts such as Under Armour (UA) and Lululemon Athletica (LULU). That’s both due to strong execution on the part of these rivals, as well as the growing importance of sports apparel, which is more prone to fickle changes in fashion tastes.

A recent Bloomberg article noted that Nike generates more annual sales than Adidas, Lululemon, Under Armour, and Foot Locker combined, underscoring the increased challenge Nike has to defend its market share and generate healthy growth figures compared to its smaller rivals.

The article goes on to discuss that Nike might be having a harder time pushing through price increases on its shoes like it has been able to do in the past. This is due to more competition but also consumers “switching out of their running and basketball sneakers in favor of more casual styles, such as the Stan Smith and Old Skool lines of Adidas and Vans, respectively.”

The chart below shows the growth rate of Nike’s futures orders, which retailers place in advance of delivery. Futures orders are a decent indicator of future demand. Nike’s growth rate has slowed considerably in North America (green line) and China (blue line).

Nike

We can’t forget that sports apparel is a cyclical industry as well, as seen by the -15% sales growth decline during the great recession. Slowing growth around the world, but especially in China, could hurt sales and make management’s goal of achieving $50 billion in revenue by 2020 (nearly 60% growth compared to 2015 sales of $30.6 billion) a tougher target to hit.

Nike’s large international presence also means that the

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