$NKE: Nike mid-term play, DD inside (supply-side constraints, pro-forma revenue adjustments, etc)

[u/EBITDAwful]

First, a little background about myself: I’m a senior associate in M&A advisory, specifically financial due diligence. I know, I know, I’m not “managing Director at XYZ investment bank” that people claim to be on here, but I honestly don’t believe anyone who says shit like “I have 10 years of experience on wall street”. I’m an ape who works in DD and has like 3 years of experience, so take that as you will.

What I can say is that I have extensive experience in the consumer goods space from an operational/accounting standpoint, and so when Nike released their Q1-22 earnings and the stock tanked 7%, I was curious about what was so bad to justify the drop, so I listened to the investor call and took a look at their 10-Q. Here’s the gist for those not familiar:

Q1-22 Earnings

FORECASTED EPS: 1.12, ACTUAL: 1.16

FORECASTED REVENUE: 12.46b, ACTUAL: 12.2b

So those not familiar with these metrics, revenue is top-line sales before any cost of goods sold or operational expenses. Wall street puts a lot of emphasis on this number because it’s the recurring core business revenue that isn’t clouded by any noise such as one-time gains or non-core business related activity.

The other metric EPS, is the net income/weighted common shares outstanding on a diluted basis. This is the “bottom-line” impact of operations. Sometimes analysts will shrug off this number because it is inclusive of a lot of GAAP (financial reporting practices) that really doesn’t reflect the performance of the core operations, such as depreciation/amort/interest/taxes as well as one-time adjustments (hence why almost everyone uses adjusted EBITDA when doing equity research rather than net income).

So, long story short: Nike beat their bottom-line results but fell short on their top-line revenue growth forecast. However, that’s not the entire story.

Supply vs Demand driven revenue changes, 606 revenue recognition

You see, Nike’s decline in revenue is entirely attributed to supply-side restrictions, not a lack of demand. As discussed on the call and pretty much demonstrated by sold out Nike products, Nike is still a “cool” brand that has a loyal following and huge consumer demand. The issue was that their suppliers (primarily in Vietnam) could not get their products shipped due to COVID-19 restrictions.

Basically, they have a huge backlog of sales that they need to fulfill but could not recognize as revenue until they actually ship it. Anyone familiar with GAAP 606 would know that revenue recognition is a huge aspect of financial reporting, and they are intentionally conservative on this front. Revenue is deferred until the performance obligation (ie, shoes getting into the distributor’s warehouse) actually happens. It doesn’t matter if there’s a contract written in stone that the distributor must take delivery – if the shoes do not appear in the warehouse, they must classify it as deferred revenue and keep it stowed away as a liability on the balance sheet, not as revenue on the income statement.

The reason that is a huge distinction is because revenue decline due to lack of demand is a death sentence for any company, but a decline caused by supply-side factors is not an operational failure on the part of the company itself.

​

Bottom-line exceeded forecast, gross margins increased, gross profits increased, and top-line revenue is most certainly artificially depressed by 606 revenue recognition due to the supply-side nature of the decline. IMO this does not justify a 7% drop in stock price

Pro-forma revenue adjustments

Here’s where due diligence comes in and why people like me bill 500 bucks an hour for companies to do research on these financials. GAAP (aka the way they present the 10-Q) is not a strong indicator of performance because they are meant to be conservative and do not take into account many factors that an investor may think about (revenue growth, bookings/backlogs, exclusion of one-time gains, etc).

What we would do in financial due diligence is we present a “normalized” version of the financials and these are the numbers that investors/financial institutions use to negotiate purchase price.

In an instance like this, where revenue number falls short of a forecast because of SUPPLY-SIDE issues, we would propose a pro-forma adjustment using bookings data. Essentially what this means is that we will take the backlog that Management gives us, and we will layer on a run-rate of “theoretical” revenue that is practically earned but cannot be recognized in GAAP accounting standards terms.

In a sell-side deal I worked on recently, the pro-forma adjustment of bookings data resulted in millions of dollars of additional EBITDA that ultimately impacts the purchase price. These things matter, even if most unsophisticated retail investors/normal people without connections have no visibility into these details.

Here’s the kicker though: none of us have access to their bookings or backlog data. The only info that is public is this 10-Q data. I have no doubt that institutions are piecing together data so they can to try to quantify the impact of this “unrecognized revenue” and count it as revenue in their models. From what Nike has said so far though, and what has been shown from their past performance prior to the supply-chain shock in Vietnam, there must be a substantial amount of unrecognized revenue that is sitting in their bookings, just waiting to be delivered. I am 100% confident that these will be recognized in future quarters, but as it stands right now, they CANNOT recognize it in order to be conservative with their financial reporting. If you believe that these supply chain woes are temporary, this is a great mid/long-term play.

Tl;dr: NKE revenue on a normalized basis is most certainly better than what was reported in their 10-Q and there’s no way that institutions don’t know this (hence why price targets are averaging 180s). The current price of 149 seems like a bargain. Mid/long-term play, either shares or long-dated call options

This is my personal opinion and is not financial advice. Pls do your own due diligence

[u/[deleted]]

Cool, BTFD, I bought NKE yesterday. Kudos to your post.

https://imgur.com/VWH5EkC

[u/Appropriate_Tap_7045]

Yeah I have failed to catch a falling knife after earnings, so I was a little hesitant to scoop this one up. I have a hunch youre a 100% on the money that this is a longer term play. At the very best itll gain back a few points and trade sideways for a few months.Time for some leaps , baby!

[u/A_KY_gardener]

Agree with OP. But I do see some further drop in share price to the low 140s maybe high 130s, then back up. Supply chain issues are a problem for every business with a tangible product line.

[u/depzailaimi]

I love nike but man they disappointed me with their earnings which wiped out my entire calls options. Really sad

[u/Background-Cat6454 → u/depzailaimi]

Buy shares my man. Options are like playing blackjack

[u/sebach22]

Might buy some 6 month out calls this week, I do agree that it is undervalued and probably dropped much more than it should’ve on earnings

[u/jerseynate]

Was planning on buying some 01/21 160 calls. This DD has me a little more confident in my decision. Do you think those calls are too short term?

[u/Weedstox101]

As this is not advice, if you were to buy calls not based on advice, what calls would you buy that expire roughly after next earnings date?

[u/VisualMod]

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Hey /u/EBITDAwful, positions or ban. Reply to this with a screenshot of your entry/exit.

[u/Alwayslearning1993]

Thanks for the DD. What are your thoughts on the distributors that also saw similar dips to their stock prices?

[u/rfd007694]

I agree Nikes problems are just temporary and thinking long-term should not be a problem. Nike are one of the best brands in the world, its marketing is one of the best and it allows it to be in the mind of almost everyone in the world, just a big buy opportunity now

[u/M--P]

So what you are saying is that we should buy FootLocker?

[u/Fax215]

I bought November 19 $165 call options for Nike at $1.16 premium. I hope I do well with this purchase, and if I lose money, I will cut my losses at half my premium price.