## Investment thesis

Nike (NYSE: NKE) needs no introduction since they are one of the most famous companies in the world. Its competitive edge is significant, but that doesn’t mean the company can’t be overvalued. Being one of the best known brands in the world is not enough to make it worth the investment.

As we can see from this graph, Nike stock price has always had a constant and upward trend, at least until 2019. From 2020, due to the pandemic, there was a general collapse of the entire stock market which also hit Nike hard ($60 per share in March 2020). Since then, there has been a major influx of capital that has pushed Nike to $180 in about a year and a half. This is a 70% increase from pre-Covid-19 levels.

Personally, I believe this strong rally was primarily triggered by general market euphoria and not improving underlying activity, so I consider Nike to be overvalued. My thesis will be confirmed by using a discounted cash flow and by doing a simple comparison of valuation multiples. My view on Nike is a strong sell, which can turn into a buy once it hits $70-75 per share. The recent drop of 35% is not enough.

## What is the fair value of Nike?

As already mentioned, the valuation of Nike will be carried out via a DCF and the method of multiples. Both of these methods are based exclusively on numeric values; therefore, they do not take into account other exogenous variables, whether positive or negative.

### Discounted cash flow

The discounted cash flow method is one of the most widely used in finance and involves discounting the value of the company’s future cash flows into the present. Since some of the values included in this model are based on my assumptions, I will consider three different scenarios to consider three different points of view: I will try to limit subjectivity. Before starting the construction of the models, however, it is good to specify what will be the free cash flow inserted in the first year. It will be from there that I will start to calculate the free cash flow of the future years and therefore the whole model is based on this value.

From what we can see, Nike’s free cash flow seems rather discontinuous but growing over the long term: from 2017 to date, it has grown at a CAGR of 8.41%. Looking from 2018 to date, the CAGR would drop to just 2.99%. In all three models, I will be deliberately non-conservative and consider Year 1 the highest figure ever for Nike, $5.8 billion. Net debt and outstanding equity values belong to TIKR Terminal and will be the same in the three models considered.

#### Best case scenario

At best, Nike is undervalued because its fair value is $132.32. However, using a 20% safety margin, it’s not worth buying Nike at the current price. In this scenario, I used a growth rate of 10%, which is much higher than what I’ve seen in the past. In addition, I considered a risk-free rate of 3% in WACC calculation, which means that I assume that interest rates will not increase in the future and that they have peaked. Given recent inflation levels, tight monetary policy and supply chain issues, I view this scenario as far too positive.

#### normal scenario

In this scenario, which I consider the most likely, Nike is overvalued by 30% since its fair value is $83.68. With a margin of safety we are far from the current price. In this scenario, in the calculation of the WACC, I considered a risk-free rate of 3.5%, a beta of 1.21 (the previous one was 1.05) and an addition of 0.25% due to possible unforeseen risks (in the previous scenario it was 0.13%). Finally, I reduced the free cash flow growth rate to 7% (still a higher growth rate than the last 5 years). These assumptions do not seem at all far-fetched, yet Nike is very overvalued.

#### worst case scenario

Worst case, Nike’s fair value is $56.94, so much less than today’s value. In this scenario, I only made two changes from the previous model: the risk free rate increased to 4% and the free cash flow growth decreased to 3%. While this fair value may seem too low, I personally don’t think it’s that unlikely. The US 10-year bond went from 1.5% in January 2022 to 3% currently in about 5 months: is it so absurd to think that it could reach 4% given the current inflation rate of over 8%?

For free cash flow growth, I just used the same as the last five years. Is it so absurd to believe that free cash flow can also increase by 3% in the future given the current supply chain problems? And finally, you also have to consider that I used as Nike’s highest starting free cash flow ever.

### Multiples method

In view of the price multiples, once again Nike is very overvalued since its multiples are much higher than those of its competitors in the same sector. It must be said, however, that I do not agree with the overall rating given to Nike. It is true that the multiples of its competitors are much lower, but historically Nike has always had higher multiples: if you want to buy a good company, you have to pay more.

I consider the current P/E of 31.30 to be excessive given Nike’s future growth, but at the same time a P/E of 12.65 equal to the industry average is excessively low. By taking the average of these two values, the P/E of Nike would be 22, a more reasonable value in my opinion. Considering the estimated annual EPS for this year is $3.75, with a P/E of 22, Nike’s fair value would be $82.50.

### Average fair value

Averaging the valuation methods used, Nike’s fair value is $94.68, which is quite a far cry from the current $118. In the calculation, I have also included the current value of Nike since I consider it to be the value that the market currently places on Nike. No safety margin was taken into account in this final calculation. If this fair value sounds absurd to you, I would remind you that in March 2020 Nike crashed to $60 and about 6 months ago it was trading at $180. Personally, I would consider an initial buy if Nike hits $70-75 per share.