NIKE (NKE - Free Nike Stock Report) shares have been strong performers over the past year, handily outpacing the broad Standard & Poor’s 500 Index. What’s more, there appear to be many more chapters to go in this iconic company’s growth story, which has already seen it go from a domestic footwear distributor to a nearly unrivaled international marketer of athletic footwear, apparel, and equipment. In fact, we expect share earnings to advance at a 15%-20% annual clip through late decade, as industry fundamentals remain favorable, the direct-to-consumer channel is more aggressively targeted, and inroads are made in emerging markets. With this outlook in mind, should investors build positions ahead of NIKE’s next growth spurt? Or has the stock market already discounted the company’s impressive prospects? In this article, we will attempt to address these questions by taking a brief look at NIKE’s business and performing an easy-to-follow SWOT analysis of the company, evaluating its Strengths, Weaknesses, Opportunities, and Threats.

The Business

NIKE, incorporated in 1968 and headquartered near Beaverton, Oregon, is the world’s leading designer, marketer, and distributor of athletic footwear, apparel, equipment, and accessories for a wide variety of sports and fitness activities. The company has around 48,000 employees worldwide and annual revenues in excess of $25 billion. And its products, manufactured by outside contractors and produced under the NIKE, Jordan, Converse, and Hurley brands, are sold to retail accounts, through NIKE-owned retail stores and Internet websites, and through a mix of independent distributors and licensees, with U.S. sales accounting for roughly 45% of the top-line mix.


Product Innovation: NIKE has a long tradition of staying ahead of the technology curve, which has helped it attract loyal followers and influential endorsements from elite professional athletes, from Michael Jordan to Tiger Woods. It’s not resting on its laurels either, most recently rolling out NIKE FLYKNIT, an innovative footwear platform that uses yarns and fabrics to create a featherweight, formfitting, virtually seamless upper. This augurs well for market-share momentum going forward, especially in the running and basketball shoe categories, where the company is looking to up its exposure. And the commitment to innovation should allow the company to maintain its pricing power in the years ahead, offsetting any commodity-related margin pressures. We expect the FLYKNIT line, meanwhile, to enable NIKE to capitalize on the growing trend toward minimalist footwear. This is a long-term secular trend, in our view, and it should continue to play out through decade’s end.

Strong Cash Flow: The company generates a lot of free cash flow, a good portion of which it uses to enhance shareholder value. Apart from a modest dividend payout (the Dow component typically yields between 1% and 1.5%), cash is used to fund an aggressive buyback program. In fact, stock repurchases typically approximate $2 billion annually, an activity that goes a long way toward supporting share net. There’s ample cash, in the meantime, for NIKE to maintain a large R&D budget. This ought to keep new and old rivals at bay in 2014 and beyond.


High Advertising Costs: Part of the company’s marketing strategy involves locking up major sports stars in lengthy endorsement deals. This has proven to be a rather successful tactic, as evidenced by the global awareness of the NIKE brand and the company’s strong share positions in each of its categories. The strategy comes at a pretty high price tag, however. (Total advertising and promotion expenses were about $2.7 billion, or nearly 11% of sales, in fiscal 2013, which ended May 31, 2013.) Moreover, we see endorsement costs, or what the company calls “demand creation” expenses, drifting even higher over time, as competition from new sector participants heats up. This will likely weigh on margins a bit, though probably not enough to counteract the productivity advances (especially in the area of labor) and greater sales leverage we envision.


Favorable Industry Trends: Among these are the growing popularity of running worldwide and the increased desire for minimalist footwear. A heightened emphasis on fashion in the athletic realm is also giving NIKE a boost, since style has always played a large role in its footwear and apparel lines. The company’s fashion focus explains, we think, why NIKE gear is universally worn casually rather than merely during sporting pursuits.

Direct to Consumer: eCommerce, in particular, represents a big opportunity for NIKE, and we expect this to be a $2 billion business annually within a few years, versus closer to $540 million today. That said, the company should continue to expand its base of retail shops and factory stores, as these locations allow NIKE to best control its brand, more effectively manage its inventory, and win new wholesale accounts. At present, there are over 750 retail units worldwide, including over 300 in the United States.

Emerging Market Growth: Conditions in China are a bit challenging these days, as that country experiences a moderate economic slowdown. But China, with its huge population and emerging middle class, still represents an excellent long-range opportunity for the company. What’s more, advances in other thriving BRIC nations, most notably Brazil (where the passion for sports is high and getting higher ahead of the World Cup soccer tournament), should easily pick up any slack in the coming quarters.


Heightened Competition: In addition to entrenched rivals, like V.F. Corporation (VFC), which markets goods under The North Face and Timberland labels, NIKE must now vie with edgier up-and-coming competitors. The most significant, we believe, are Skechers USA (SKX) and Under Armour (UA), the latter of which has been growing at a blistering pace since going public in 2005 and has done an enviable job of reaching out to young consumers.

Product Cost Inflation: Rising raw material costs are apt to be a long-term headwind, with the developing world continuing to use up more commodities. Labor inflation will likely be an issue, too, but, as we’ve suggested, we see NIKE making productivity improvements in this area.


In sum, we still find the NIKE story very appealing and far from over, and expect inroads in emerging markets and the direct-to-consumer channel to drive the bottom line for years to come. And while this high-quality stock is not a bargain, trading at around 25 times forward earnings, it ought to provide investors with good risk-adjusted returns through the 2017-2019 time frame. We think that it would make a fine addition to most diversified equity portfolios.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.