About a week and a half ago we made a bearish bet in NKE given its poor relative performance to the broad market and suggesting that high valuation consumer discretionary names could be vulnerable in the near term. Since initiating the position on January 10th, the stock has sold off about 4.5% and the put spread we bought is worth more than double what we paid. With the stock approaching the short strike of the put spread, and with one month to expiration, we are not going to wait around and try to capture the spread’s intrinsic value. We are going to take the quick profit and move on as some investors could get excited about NKE’s prospects as we get closer to the Olympics starting in early February.
Action: Sold to Close NKE ($73.70) Feb 77.50 / 72.50 Put Spread at $3.15 for a 1.65 profit.
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Original Post Jan 10th, 2013: New Trade $NKE: Out of Fuel?
Back on December 19th, NKE reported a strong fiscal Q2 quarter that was highlighted by better than expected gross margins and futures orders, two metrics that are very closely watched by analysts and investors. The stock had a very muted reaction to the results (down 1% the next day) as Goldman Sachs Equity Research (who rates the stock a Buy with a 6 month price target of $87) highlighted what they called a “controversial new data point”:
the extent to which NKE is reinvesting sales and gross margin upside into SG&A. This is a frustration for those waiting to see EPS flow-through, but, given the high quality growth opportunities we see for NKE across a number of pillars (international markets, direct-to-consumer, and supply chain), we believe the reinvestment makes strong strategic sense.
Other data-points holding the stock back could be the 11% rise in inventories in the quarter, and the slow recovery from Emerging Markets (ex China which was up 5%) as Barron’s cited on Dec 20th:
“Revenue from emerging markets disappointed management: it increased 3% year over year, but was down 4% with the negative effect of currency. Management cited Mexico, where a switch to a third-party logistics provider earlier this year has resulted in delayed shipments. Nike said it will take “a few quarters” to fully regain business at retail and address-related inventory issues.
Following the quarter, Goldman Sachs did reduce their fiscal 2014 EPS estimates by almost 5% as result of the increased cost that are likely due to what NKE management calls “demand creation” aka paying LeBron and Kobe!
So the question investors need to get an answer to, is this increased spending and inventories in preparation of the Olympics in February and the World Cup this summer, and will it result in increased sales? I obviously don’t know, but I do know that the stock feels a bit tired at the moment, failing to make a new high with the SPX last week and approaching near term technical support at $75 (red line below).
The six month chart below shows the stock’s recent break below its 50 day moving average (purple) on rising volume:
I can’t sit here and tell you that the chart looks horrible, it just looks tired to me, and with some of the price action this week in once loved consumer discretionary stocks like BBBY (down 13% ytd) and WFM (down 9% ytd), my sense is that a stock like NKE trading at 25x this years earnings that are expected to grow at 11% on sales growth of 10% is priced to perfection.
NKE does not report earnings next until March 20th, so the stock will see few if any company specific catalysts given the backdrop of what is amounting to weakness in Emerging Markets to start out the year, but a stock like NKE could be vulnerable at these levels given their exposure outside the U.S. and their reliance on emerging markets for growth.
Trade: NKE ($77.05) Bought Feb 77.50 / 72.50 Put Spread for 1.50
-Bought 1 Feb 77.50 Put for 1.95
-Sold 1 Feb 72.50 Put at .45
Break-Even on Feb Expiration:
Profits: between 76 and 72.50 make up to 3.50, below 72.50 make full 3.50
Losses: between 76 and 77.50 lose up to 1.50, max loss of 1.50 above 77.5
Trade Rationale:
The structure benefits from being slightly in the money with a delta of about 35. This is the type of trade that only needs a continuation of the recent selling bya few more dollars to be nicely profitable with the outside chance of market weakness to help it below nearby support of $74. We’ll likely keep a stop on this structure to the upside in case the market and NKE reverse the early January trend and start marching higher. We’d likely cap out losses at about 50% of the price of the structure on a rally from here.