Update: NKE Trade Management

by Dan December 21, 2011 10:08 am • Commentary

Trade Update Dec 21st, 2011 at 10:20am:  Well this trade was a total bust, even with generally uninspiring results with eps and sales that only slightly beat expectations, and with margins weaker as a result of higher input costs…..I guess the only reason the stock is up is that their future orders were up 13% year over year.  With the stock underperforming (only up 2%) the implied move that was about 5% vs the 4 qtr avg move of about 7.5%, I am hard-pressed to think what the stock might have done on a miss…..my point is market participants were not pricing in any fireworks, and they clearly didn’t get it.  My play was that with the stock where it was and the perceived “cheap” move the only way to really play was by picking a direction.

It is also important to note that the use of Dec23rd weekly options made this a pure event play and with the stock not moving the air has been sucked out of this put spread and without a significant move in the next few days this will be a total loser.

I get this question a lot and I think GMCR demonstrated the answer last week, but some may ask why not sell the long strike for say a nickel?? and my answer is very simply that there is no real upside in doing so, especially in a market with such high correlation and with volatility still elevated.


NKE reports their fiscal Q2 tonight after the close, the options market is implying about a 5% move following earnings vs a 4 qtr avg move of about 7.5%.

-The stock is up 10.5% ytd vs the SPX which is down about 1.5%.

-NKE isn’t exacly cheap on a valuation basis trading at about 19x consensus eps for their fiscal 2012, with only expected eps and sales growth of about 15% for the next 2 years.

-Wall street analysts are generally positive with 16 Buys, 8 Holds and No Sells, while short interest is generally low at less than 1% of the float.

In a note to clients on Dec 19th Citi had the following to say in their quarterly preview:

Recall That We Recently Added NKE to Citi’s Top Picks Live! — On 12/7/11 as we  believe NKE stock is going higher on revenue/margin beats on accelerated futures &  higher gross margin guidance. We rate NKE a Buy with a $113 target price on strong  revenues from emerging market exposure, innovation driving footwear sales, price  increases, and direct channel strength. We also see dividends (+16% increase ann. 11/17/11 and repurchases (we est. ~$2.1bn TY) as supporting stock.

We Also See Improved Gross Margin Guidance — To (30)-(50)bps from (100)bps
on better visibility into price increase acceptance. Also, cotton is likely to be a margin  helper 1H of FY13 (see our 9/12/11 note on ’12 Product Cost strategy) & strong sell  throughs at retail could imply less Y-o-Y markdown money contributions from NKE. Note that Citi currently models -40bps of gross margin pressure this year.

In a note to clients on Dec 14th, Merrill Lynch had the following to say in their quarterly preview:

We believe Nike will report solid F2Q12 EPS and global constant $ futures (fcst.  +11.3%) given continued strength in athletic footwear, int’l momentum, improving  US apparel sales, and a MSD% benefit from price increases in 1H12, offsetting continued pressure from rising input costs and elevated air freight vs. LY. Our  F2Q12E EPS is $0.99 (vs. cons. $0.97) and F12E EPS is $5.00 (vs. cons. $4.98). Our PO remains $105, 18-19x our F13E EPS of $5.70.

Product costs and price increases remain a focus
Nike guided F1Q12 GM down at least –(200bps) and –(100bps) for F2012 (both inline with our fcst.) as a result of rising input costs and elevated air freight vs. LY.  Nike plans to execute a broad based price increase beginning in 2012.  A strong launch schedule  should support Nike’s pricing power but the challenging global footwear sourcing cost env’t should pressure thru F2012 with costs expected to be up ~10% y/y.

Well It was hard to find some cautious commentary heading into the quarter, But Credit Suisse in their Preview Note from Dec 19th had the following to say:

We expect solid momentum in the Americas and Emerging Markets to drive
earnings power in F2Q. Our cautious thesis on the stock remains predicated on
ramping SG&A requirements heading into the Olympics, holding back earnings
growth over the balance of the year. Should demand momentum, or benefits
from pricing increases be better than anticipated (modest probability), we could
be proven too cautious.

Top-Line and EPS Momentum Likely Solid in F2Q. Given signs of strong  demand for athletic footwear and apparel in the U.S., continued demand in
emerging markets, as well as expectations that price increases are being
successfully digested by retailers, we see some potential for upside to our
F2Q revenue and EPS estimates for $5.589B and $0.95, which are modestly
below consensus for $5.630B and $0.97.

Expecting Low Double Digit Futures Growth. We are expecting constant
currency futures growth of 10-12%, as continued strength in the Americas
(10%), emerging markets (18%), and Eastern Europe (13%) is offset by
continued weakness in Western Europe (4%) in spite of the Olympic lead-up
as retailers are ordering cautiously and shifting to at once orders in light of
shaky macroeconomic conditions. We also note that disruption in the
Chinese athletic apparel market (local pla0yers over-inventoried and
engaged in a pricing war) could hold back China futures (15% versus 22% in
F1Q). Please see Exhibit 1 for complete futures and sales growth


Technicals: The stock is up about 22% from the August lows, and only down about 4% from the 52 week highs made Dec 9th, less than 2 weeks ago.  With the stock 3.00 off of this mornings highs it appears that some of the enthusiasm heading into tonight’s print is waning ab it and a lot of good news could currently be in the stock.  ALso the previous low in Nov is right around a big support level of about $90 which also happens to be the 100 day moving average at about 89.75.

1 yr NKE chart form Bloomberg

MY TAKE:  While I am a huge fan of this company and their products, I am not exactly a buyer of momentum stocks like this that have outperformed the broad market.  The implied move looks cheap to me, and if you have an inclination as to direction, this could set up asa decent name to play for an outsized move.  As I have stated a few times of late, playing for outsized moves had been a bit more rewarding on the short side than it has on the long sides, as in volatile market like these, investors have a greater tendency to shoot first and ask questions later on stocks of companies with disappointing news as opposed to jumping over each other to buy stocks of companies with perceived good news.

While North AMerica still makes up about 1/3 of NKE’s sales, Europe, emerging markets and Asia make up a greater amount.  Any slowdown in Europe or in China can have a dramatic effect on their earnings.  ALso the company faced some disruption earlier in the year with the disatser in Japan and the ensuing increase in input costs that hurt margins……Any signs of such disruption from slowing demand in Europe or China could send the stock lower near term support.  I obviously have no strong edge here and I am fading a stock that has acted well into the end of the year but has also traded in a wide range btwn 70.00 and 98.25.

TRADE: NKE ($93.20) BOUGHT the DEC23rd Weekly 90/87.50 Put Spread for .60

-Bought 1 Dec23rd 90 Put for 1.15

-Sold 1 Dec23rd 87.50 Put at .55

Break-Even On Dec23rd Expiration (this Friday):

Profits btwn 89.40 and 87.50 make up to 1.90 or 3x your money, 87.50 or below make full 1.90

Losses btwn 89.40 and 90 lose up to .60, and above 90 lose full .60

TRADE RATIONALE:  I believe the move is priced cheap and as many of you would expect I like to place my chips into events on names that I think are extended technically and where sentiment is too positive.  In this instance I also have the benefit of the options market pricing something I believe to be too deep.  Now Of course the hard part is getting the direction right and in this instance I would much rather choose lower than higher. My sense is that the qtr to be reported was probably fine, but any cautious comments about input costs or the global macro situation hurting visibility and the stock should be lower.

As for choosing a spread that is a few % out of the money, if the move is in fact cheap and I get the direction right then this should not be an easy one to break-even on, yes those are a bunch of ifs……