NKE Beats with Dollar Currency Upside

http://money.cnn.com/2008/06/25/news/companies/nike_earnings.ap/?postversion=2008062518

Nike sales grew 16% to $5.1B from $4.4B. Earnings grew ~14% (and EPS beat by $0.02 (2%)). From $438M to $490M

* US sales grew 4%

* Asia sales surged 39% to ~$828M from $595M.

* EU grew 19%

But the sales and earnings story is actually quite bad and bodes poorly for the future.

* Sales growth was only 8% after subtracting currency transaction gains.

* "Changes in currency exchange rates increased revenue by 7 percentage points for the quarter." Of the $700M growth, fully $350M was from currency gains

Earnings on a year-over-year basis fell nearly 40%:

* One-time earnings gain of $32M from a sale of Nike Bauer Hockey

* Lower tax rate added ~$15M

* $150M came from currency gains.

Let's revisit the issue of currency gains.

When the dollar weakens, overseas sales results look bigger in dollar terms. Last quarter, it was 15% cheaper than last year against the Euro. If Nike sells 25M shoes in China and Europe, they would have gotten $1B last year and $1.15B this year. In essence, Nike unit sales are virtually flat.

Nike will continue to enjoy this weakness until the end of the year.

For the next quarter, the dollar looks set to be ~13% cheaper than last year. (BTW, the $/Euro rate drop is similar to the $/Yuan rate drop, so the Euro rates are applicable.)

But look at the end of the year: the $ weakness falls to ~8%. In fact, we could even see some dollar strength, which would drive that 8% down. (Note: the dollar has been moving up the last 2 months and a weaker Europe will drive $ strength.)

A breakdown of this quarter's sales growth shows the following:

* 50% dollar weakness

* 25% US growth

* 25% Global growth

By Q4, two of the 3 growth factors disappear: no more dollar weakness and no more US growth (per Nike, they expect flat US growth). In fact, a pullback in US sales would negate any global growth.

I am forecasting a flat Q4. Analysts expect 10% Sales growth for the next 12 months. Meanwhile, I expect costs to increase. China has been increasing clothing prices. As reported by NKE this quarter,

* COGs rose from 29% to 33.1%

Flat sales and higher costs will mean falling EPS. (Note: NKE is forecast to have a lower EPS next quarter because they enjoyed a special tax gain last year)

CONCLUSION

Overpriced by ~15%

* PE is too high: NKE has a 15 forward P/E for 10% growth (and that is net $2B cash).

* EPS will probably drop from forecast $3.95 to $3.75

Current 15 P/E on $3.75 drives a $59 price. A lower P/E will drop it to $50.