Event: NKE reports its fiscal Q3 earnings tomorrow after the close. The options market is implying about a 4.5% one day move, which is slightly below both the 4 qtr average of 4.75% and the 8 qtr average of about 5%.
Sentiment: Wall Street analysts are generally positive on the stock, with 16 Buys, 15 Holds, and No Sells, though the average 12 month price target is only around $81.50. NKE is up 1% on the year, an impressive turnaround after being down about 10% as of early February. NKE has rallied about 45% over the last year. Short interest is negligible at 1% of the float.
Options Open Interest: Open interest is skewed towards calls by a ratio of 1.6 to 1, and the one month average daily volume has heavily favored calls, by a ratio of 2.75 to 1. The Mar22nd 80 calls have been the most active line in the past week (open interest now 17k), as NKE approaches its all-time high of $80.26, set on December 3rd. The stock has failed to get through $80 on several occasions this month. The Apr19th 80 calls have the second most open interest, at around 8k in total.
Price Action / Technicals: NKE tested its 200 day moving average in early February for the first time in more than a year. The rising 200 day ma held, and the stock quickly bounced from there, rising to near $80 in almost a straight line:[caption id="attachment_37713" align="alignnone" width="600"] NKE daily chart, 200 day ma in yellow, Courtesy of Bloomberg[/caption]
The $75 level is the first line of support, with $70 more important long-term support after the February low. With the stock right at the $80 level, there is no resistance above here if the stock gaps higher. NKE has closed higher in each of the past 5 years, with the last down year in 2008, so buyers are used to being rewarded to buy the dip in the stock.
Fundamentals: We wrote the following in last quarter’s earnings preview:
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.
NKE reported a weaker-than-expected number in November, and the stock declined over the next 6 weeks before bottoming in early February. However, NKE has made it all the way back up to its pre-earnings level from December, near $80. Its trailing 12 month P/E has risen back to a new 10 year high in the process:[caption id="attachment_37714" align="alignnone" width="600"] Trailing 12 month P/E in NKE, Courtesy of Bloomberg[/caption]
With that stretched valuation vs. history, the risk/reward still seems skewed to the downside if NKE fails to deliver vs. expectations in 2014.
Volatility Snapshot: NKE 30 day implied vol is in the high 20’s, which is lower than it has been for the past 4 earnings reports:[caption id="attachment_37712" align="alignnone" width="600"] NKE 30 day implied vol, Courtesy of LiveVolPro[/caption]
Realized volatility has become more subdued in NKE over the past few months, as it has traced out a range between $70 and $80. Implied volatility is likely to fall back into the high teens after the event.
Our main view on NKE is that the stock is still quite rich from a fundamental perspective, but old habits die hard among investors. As a result, we’ve traded both sides on the stock with a focus on technicals, though our longer-term view is that NKE is going to have a more difficult time in 2014 given the elevated valuation vs. history and the company’s international exposure.
As for this quarter, expectations are relatively low after last quarter’s weakness, with analysts actually expecting a 1% decline vs. last year’s March report. However, guidance will be important as analysts are quite optimistic about the next 4 quarters. Moreover, the summer selling season will be notable with the World Cup in June and July.
With low expectations for this quarter, but a rich valuation, we don’t see a standout trade of the earnings event. We’ll be on the lookout for vol discrepancies if implied vol falls significantly in the coming week after the event.