Nike vs. Foot Locker
I love Twitter. If you are serious about growing your investing knowledge and skills base, you would be nuts not to be on Twitter. The FinTwit community is outstanding and the amount of information and analysis available is incredible.
It also gives me a great platform to really engage with my readers and followers. For example, I enjoyed this question posed to me:
I didn’t screenshot the graphs that came with the tweet as it would’ve been a mission for you to see properly. The other company being referred to is Nike.
In Ghost Mail this week, I used this idea to run my readers through the high-level approach I take to analysing companies and comparing them to one another. If you still aren’t a subscriber to Ghost Mail (which is completely free), you can fix that situation at this link and significantly improve your inbox every Tuesday morning at 6:15am.
This article is the output of that process, including the initial financial analysis. It should be a useful read for you even if you didn’t read Ghost Mail this morning.
What do these companies do?
Unless you’ve lived under a rock your entire life, you should know what Nike does. Many people don’t know how to pronounce the name properly (pro tip: it doesn’t rhyme with bike), but everyone knows the famous swoosh mark.
As an aside, the story of how Nike was started is called Shoe Dog. It’s a brilliant book and I highly recommend reading it.
Foot Locker is an international shoe and apparel retailer. Foot Locker sells Nike products alongside Reebok, New Balance and all the usual suspects. Think of it as a global version of your favourite local sneaker store.
Although the end customer is essentially the same person, the business models aren’t perfectly comparable. Nike is one level up in the value chain – the company designs and manufactures products, whereas Foot Locker just distributes them. Nike also sells directly to end users, disintermediating the likes of Foot Locker and thus taking the wholesale and retail profit margins for itself on a portion of its sales. This is a critical point for you to remember.
Nike’s recent performance
Nike has a year-end of May for some odd reason. That’s not the only unusual thing about the financials, as you’ll find out shortly.
In the year to May 2021, Nike grew its sales revenue by 19%. Gross profit margin came in at 44.8%, 140bps higher than the previous year (i.e. the comparable period was 43.4% because 140bps means 1.4% – I’m just using the correct terminology).
Hysterically, the next line item on the income statement is “demand creation expense” which is what happens when brand people are allowed to use the same kitchen as the finance team. I can only assume that this means marketing and selling expenses.
I promise I’m not making this up. See for yourself:
It must have been cheaper to create demand in the past year, as that expense dropped 13%. Overheads only grew 4% despite the strong sales growth, so profit margins have grown sharply in the past year.
For some reason, there’s no operating profit sub-total. You would calculate this by subtracting selling and administrative expenses from gross profit. In the 2021 financial year, that would be $19,962 – $13,025 = $6,937. Dividing this number by revenue gives us operating profit margin of 15.6%. In the prior year, it was just 8.3%.
At this stage, you might be tempted to close this article and place your bid for shares. Considering the global Covid disruptions last year, I always recommend comparing to 2019 as well.
Here’s a snapshot from Nike’s 2020 annual report:
Operating profit margins aren’t shown above but you can calculate them in the same way I demonstrated for 2021. We can summarise the operating profit margins as follows:
- 2021: 15.6%
- 2020: 8.3%
- 2019: 12.2%
- 2018: 12.2%
It goes way beyond the scope of this article, but the next step would be to figure out whether the improvement in operating profit margin in 2021 is sustainable. A read through the Q4 earnings transcript shows that management is bullish about this performance as a new baseline, which means they anticipate these margins to stick around.
Much of this uplift would’ve come from a shift to digital channels and direct-to-consumer sales, which hurt distributors (like Foot Locker). Nike is focused on creating relationships with customers through membership programmes and the like. If margins stay where they are (or grow further), this is at the expense of independent sneaker stores across the globe.
My final comment on Nike is on diluted earnings per share, which calculates earnings per share after taking into account all the free or discounted shares that will be dished out to management. It has grown from $1.17 in 2018 to $3.56 in 2021. That’s an annualised growth rate of 74.4%, which is immense.
Speaking of immense, John J. Donahoe II (President and CEO of Nike) earned $54m in the 2020 financial year. I can’t speak for John J. Donahoe I, but I’m reasonably confident that even John J. Donahoe XXIV won’t have to worry about paying the rent.
Naturally, a full look at Nike would go into balance sheet analysis etc. This is a brief comparison between the two companies, so I need to move on to Foot Locker now.
Foot Locker’s recent performance
Here’s another weird year-end for you: January. The latest results are for the second quarter which ended in July. This gives us six months’ worth of financial results in this financial year.
Foot Locker’s recent sales growth has been driven by demand in the women’s and kids’ footwear business. Promotions were kept to a minimum, which helped drive profits. CNBC reported that analysts were expecting a 0.2% decline in revenue, but the company managed an increase of 9.5% – a terrific example of “beating the street.”
You can have a detailed look at Foot Locker’s second quarter results here. Before you get too excited about the performance in the latest quarter, take a look at this screenshot from Foot Locker’s 2020 annual report:
As you can see, Foot Locker cannot hold a candle to Nike. The company is going sideways at sales level and return on invested capital (ROIC) is dropping every year. 2020 was obviously impacted by the pandemic but it was rough before then.
No wonder analysts weren’t expecting much from the company.
Foot Locker simply doesn’t have the brand or business model strength that Nike does. Nike’s new strategy is clearly to sell directly to consumers, growing margin in the process. That is bad news for businesses like Foot Locker.
High-level views on valuation
I’ve included long-term share price charts from Google Finance and screenshots of valuation measures from Yahoo Finance. There’s so much free stuff available online.
We now know that Nike has done well during the pandemic and has moved towards a business model with higher margins. Although this is a very long-term chart, I’m still nervous of how sharp that recent spike is relative to pre-pandemic growth.
The joy of being a household name during a time in the market when stimulus has been huge and trading apps are plentiful is that people pile into your shares. This is exactly what has happened to Nike.
Poor Foot Locker, on the other hand, really isn’t a share you can buy and forget. The trend here is sideways action and general disappointment for investors. To make money from Foot Locker, you have to cleverly time your entry and exit point.
Unfortunately, Nike is expensive at the moment. Paying around 33x EV/EBITDA is serious commitment to a company. There will be a practical limit to savings in “demand creation costs” and the like, which means earnings growth should start coming down towards sales growth (19% in the past year). If we use the P/E ratio of 47x, then Nike has to grow diluted EPS by 47% to be trading on a PEG ratio of 1x, which is a simple but useful rule of thumb that compares the P/E ratio to the growth rate in earnings.
Foot Locker is a lot cheaper but you’re getting what you pay for here. I fear that other manufacturers like Nike will copy the swoosh’s success and try sell directly to consumers, causing more trouble for Foot Locker. A P/E of 9.6x isn’t a demanding multiple but I don’t get excited about Foot Locker’s prospects.
Naturally, if you are serious about buying into either company, you still have to do far more research than this. I would strongly suggest working through the financial reports of the companies in detail, including earnings calls going back several quarters.
If you forced me to choose one right now, I would buy Nike. I would do so begrudgingly, with this tweet from one of my favourite FinTwit accounts summarising the risk perfectly (note: Hedgehog’s tweet was unrelated to Nike):
In other words, a great company at a huge multiple can still be a terrible investment. When valuations look more reasonable, I would happily add Nike to my portfolio. Keep an eye out for a juicy dip from the swoosh.
Foot Locker? Not for me, thanks. If anyone thinks it has a truly compelling story and that I’m missing something, I’m all ears.