Nike

We have written in general terms about the kinds of companies that we like. Now might be a good time to discuss an example of a specific stock that we have recently purchased.

Nike is one of the great global brands in the world today. They are the world’s largest manufacturer of athletic footwear under the Nike, Converse, Umbro, Cole-Haan and Hurley brand names. They also produce athletic clothing and equipment.

At $44, we can purchase this great company for under 12x FY2009 earnings (May year end). The company has over $4 in net cash on the balance sheet, so when you strip that away, you are buying Nike for around 10x earnings. That is not a bad price to pay for a one of the strongest brands in the world.

Analyst estimates of $4.15 for FY2010 are reasonable, but given the economy I would not want to bank on it. Still, Nike has some flexibility on its income statement. It spends 32 cents of every sales dollar on Selling, General and Administrative expenses. Much of that is spending related to building the brand. Now Nike would not (and should not) starve the brand, but it has the ability to modestly reduce its spending as a percent of sales. Over the last 5 years, SG&A spending has grown by almost $2 Billion and from 30% of sales to 32%. On the last conference call management highlighted better SG&A management as one of its objectives.

The company is focused on improving its gross margin. Management continues to work on a supply chain initiative that will shorten the lead time on products. This will help to lower costs, reduce Nike's inventory and improve its on-time performance with its retailers. The company also is implementing lean manufacturing to lower its product costs.

Nike had FY2008 sales of almost $19B and has a goal of reaching $23B in sales by 2011. While that goal may be more difficult given the economic headwinds, it is certainly not unreasonable. The company will benefit from its continued innovation (like its lightweight Flywire technology and its Lunar Foam cushioning system) and growth in its “other” businesses (like equipment, golf and Umbro). The company is also expanding its apparel business and has a very focused initiative directed toward woman.

It is also very important to remember that Nike is a global company. Just over 1/3rd of its revenue comes from the US. China now makes up $1B and is growing rapidly. The company is seeing attractive growth in other markets like Russia and Brazil.

Management of the company is very strong. Mark Parker has been CEO for the last 3 years and has been with the company since 1979. The president is Charlie Denson, another long time Nike employer. Don Blair is the CFO. He has been with Nike since 1999, and previously worked for Pepsi. Co-founder, Phil Knight, is the Chairman of Board and the company’s largest shareholder. All of these men are immersed in the Nike culture and understand the importance of building the brand.

Nike has shown a commitment to returning money to shareholders. Over the last 5 years, the company has quadrupled its dividend. The yield of 2.3% is not overly attractive, but I believe the company will continue to grow the dividend by a low double digit rate in the coming years. The company also is committed to buying back its stock. In FY2008, the company repurchased over $1.2 B of its own stock. This year, it has already spent $650 million. Based on the current authorization, the company can buy back over $5B in stock over the next 4 years (20% of its outstanding shares). The reason Nike can be so generous returning money to shareholders, is because the business is a cash machine. In FY2009, I expect Nike’s free cash flow will be at least $1.6B, or almost $3.50/share.

A company that sells a discretionary item like athletic apparel may see some modest near term weakness, but with the continued growth opportunities in many markets throughout the world, that weakness will be mitigated. In the meantime, I am quite happy to own a company with such a strong brand, excellent management team, innovative culture and pristine balance sheet at a very reasonable valuation.

(Disclosure: Harvest Financial Partners owns Nike in its client portfolios. The author owns Nike in his personal portfolio. Positions may change at any time.)