Frank Curzio's WALL STREET UNPLUGGED Podcast

This Industry-Leading Growth Stock Could Fall 20% This Year

Nike (NKE) could do no wrong in 2015.

The sports apparel giant is coming off one of its best years ever. Sales surged to an all-time high, earnings jumped over 20% and the company grew its market cap by more than $30 billion.

Nike was also the best-performing stock in the Dow Jones index. Shares rose 31% while the S&P 500 reported a slight loss on the year.

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Wall Street is still super-bullish on the stock. For example, there are 30 institutional firms, like JPMorgan and Goldman Sachs, who provide research on Nike.

Yet, not one of these analysts has a sell rating on the stock!

My suggestion is, if you’re sitting on big gains in this stock, to ignore these bullish reports and grab those gains right now. The stock is trading at its highest valuation in 10 years. Plus, several headwinds could push shares down 15% to 20% in 2016.

Let me explain …

Nike’s run over the past 12 months is nothing short of impressive. The company increased sales by double-digits in every geography. It also generated $2.3 billion in free cash flow and is sitting on more than $6 billion in cash on its balance sheet.

Management is using this cash to increase its dividend. They recently raised their annual payout by 14%. They also plan on buying back $12 billion of its stock by 2020. This amounts to 11% of the company’s total shares outstanding.

Based on these facts, I understand why just about every analyst covering Nike remains bullish on the stock. However, there is much more to this story …

For example, Nike’s shares have run up by more than 30% over the past 12 months. The stock now trades at 27 times forward earnings.

To put this in perspective, Nike is trading at a 60% premium to the S&P 500. At 27 times earnings, Nike is also trading at its highest valuation in more than 10 years.

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Valuation should not be the sole reason to sell any stock.

After all, some of the best-performing stocks like Facebook ($FB) and Netflix ($NFLX) are extremely expensive based on their price-to-earnings ratios. However, these companies deserve these premiums since they are growing much faster than the overall market.

Nike is also growing earnings much faster than the market. Last quarter, earnings grew by 21%. That’s much higher than the average company in the S&P 500 — which is growing earnings in the single-digits.

But my research tells me Nike’s latest earnings report is deceiving …

For example, Nike earned 90 cents a share in the quarter. This was 4 cents higher than consensus estimates. But roughly 7 cents in earnings was due to a lower tax rate (tax rate fell from 25% to 19%) and share buybacks.

If we take out the favorable tax rate and buybacks, Nike would have missed earnings by 3 cents. Revenue also came in below consensus estimates.

These details were overshadowed by Nike’s huge 20% growth in global future orders. These are orders the company expects to book over the next 12 months.

Nike’s future orders number was impressive. But a lot of this growth is coming from China. In fact, future orders in the emerging market grew by 35%.

This could be a problem for Nike.

China is off to a rough start this year. Recent economic data shows the country is slowing at a much faster rate than expected. That’s why China’s market plunged this week.

The unexpected slowdown in China could impact future orders going forward. For example, future orders are not guaranteed orders. The company points this out in their annual report by saying:

“Exchange-rate fluctuations as well as differing levels of order cancelations, discounts and returns can cause differences in the comparisons between future orders and actual revenues.”

This may explain why Nike did not raise its full-year sales guidance — despite reporting one of the biggest jumps in future orders in the company’s history.

Another negative that’s being overlooked is inventory. Nike’s inventory in North America rose by 11%. North America accounts for almost half of the company’s revenue.

Management downplayed this risk on the conference call. But this will likely result in lower margins at least over the next three to six months. With Nike trading at 27 times forward earnings, this risk is not priced in to the stock.

On a final note …

Nike projects it will generate $50 billion in sales by 2020. That’s a 66% increase in revenue, or more than 10% annually over the next five years.  This is a big number for a company that’s already a major player in just about every global market.

Yet, Nike only expects sales to increase by 5% in 2016. That’s a significantly low number considering the “tremendous opportunity” management is anticipating from the Olympics and the UEFA Euro Championships. These are not annual events, or catalysts that will benefit Nike in 2017.

In other words … if Nike can’t grow sales by double-digits in 2016 …  how will the company generate double-digit sales growth each year until 2020?

Nike is one of the all-time great companies. They are a world dominator in sports apparel and sneakers. But even world-dominating stocks become overvalued at times. A good example of this is Wal-Mart (WMT) and Caterpillar (CAT). These stocks fell by more than 25% in 2015 — after hitting new highs the previous year.

I expect Nike to follow in the same footsteps.

Analysts’ estimates are too optimistic … there are inventory concerns in the company’s largest market … and the stock is trading at its highest valuation in more than 10 years.

My suggestion is to ignore the Street’s bullish forecasts, and sell Nike.