$NKE Fiscal Q2 Earnings Preview

by Enis December 19, 2013 10:07 am • Commentary

Event:  NKE reports its fiscal Q2 earnings tonight after the close.  The options market is implying about a 4.5% one day move, which is below both the 4 qtr average of 6% and the 8 qtr average of about 5.25%.

Sentiment:  Wall Street analysts are generally positive on the stock, with 16 Buys, 14 Holds, and No Sells, though the average 12 month price target is only around $81, given the stock’s very strong run in the past year, up more than 50% in 2013.

Options Open Interest:  Open interest is actually skewed towards puts, with about 87k calls outstanding and 103k puts outstanding, though most of the puts are not in play since the stock has rallied so much this year.  The one month average volume as been skewed to calls vs. puts by a ratio of 1.6 to 1.  The Dec 80 calls have over 7500 in open interest, while the Dec 72.50 puts have over 4k of open interest.  For Jan 18th expiry, most of the open interest is concentrated in the 77.50 and 80 call strikes.  

Price Action / Technicals:  NKE broke out to a new all-time high above $57.50 in March of this year, and never looked back.  The stock has been on a tear throughout 2013, up more than 50% year-to-date.  NKE has spent very little time below its 50 day moving average (in pink below):

[caption id="attachment_33971" align="alignnone" width="600"]NKE daily, 50 day ma in pink, 200 day ma in black, Courtesy of Bloomberg NKE daily, 50 day ma in pink, 200 day ma in black, Courtesy of Bloomberg[/caption]
The stock has also found support in the past two months at the $75 level (marked in green).  In fact, the stock’s low last week of $75.42 was another successful test of support that held.
Below $75, the next real support is around $70, with the rising 200 day moving average now around $67.  On the upside, the stock’s recent all-time high was $80.26 registered on December 9th.  That will be the next hurdle if the stock has a strong earnings report on Thursday after the close this week.

Fundamentals:  Nike remains one of the strongest brands in the world.  The company has actually doubled sales in the past 10 years, an impressive feat for a company that was already well established and well known a decade ago.  In that period, the company has grown sales at a 8%+ annual pace in every year except 2009 (which was down 6%).  Earnings have almost tripled in the past decade.

North America has been the real bright spot in 2013, driving the majority of sales growth.  NKE has guided to continued consistent performance in 2014, signaling 5-10% sales growth, and 10-15% earnings growth.  Investors in the stock have become accustomed to such consistency, and NKE’s valuation multiple has risen as a result.

Therein lies our main concern with the stock.  It could certainly continue to rise (we had the same concern in last quarter’s preview, and the stock is up more than 10% since then).  However, NKE’s trailing 12 month P/E ratio at a 10 year high is noteworthy nonetheless:

[caption id="attachment_33972" align="alignnone" width="600"]NKE 12 month trailing P/E, Courtesy of Bloomberg NKE 12 month trailing P/E, Courtesy of Bloomberg[/caption]

Volatility Snapshot:   30 Day implied vol has ramped up into the event and is at similar levels to the past few earnings cycles:

[caption id="attachment_33973" align="alignnone" width="600"]NKE 30 day implied vol (red) vs. 30 day realized vol (blue), Courtesy of LiveVolPro NKE 30 day implied vol (red) vs. 30 day realized vol (blue), Courtesy of LiveVolPro[/caption]

Implied volatility is likely to fall to around the 20 level after the event.  Realized volatility has been quite low recently since the stock has traded between 75 and 80 for most of the past 2 months.

Our View:  Given NKE’s rich valuation, the foundation of the 2014 bull argument for NKE is rather shaky, despite the company’s strong, consistent business execution over the past few years.  At a certain point, the price investors are paying for each dollar of earnings will become too rich.

In the meantime, this earnings report will be especially important for what it will say about 2014 guidance, which includes the 2014 World Cup, an obvious driver for sales next year.  We have little interest in fading such a strong momentum stock, but are even less interested in trying to play the long side at these levels.