Nike Just Didn’t Do It
Last week, I closed out an options trade on shoe retailer Nike (NYSE: NKE) for a 100% profit in less than two months. A put option increases in value when the price of the underlying security goes down.
At the time, the stock market was in rally mode. After bottoming out in late October, most stocks rallied strongly through the end of the year.
That is not usually the best time to open a put option position in a stock. When animal spirits are running amok on Wall Street, even a weak company can find some support.
But I had enough faith in my Mayhem Trader stock screener to trust what it was telling me. After rising from below $90 to above $115 over the previous two months, NKE had become overbought and was in the “kill zone.”
At that price, Nike was valued at 31 times forward earnings. That is nearly twice the same multiple for the S&P 500 Index. In short, Wall Street was betting that Nike would report stellar quarterly results later that month on the strength of holiday sales.
That belief was fortified by Nike’s decision in November to increase its quarterly cash dividend by 9%. Presumably, the company’s board was anticipating a spike in free cash flow and wanted to share the wealth with its shareholders.
Nike’s President and CEO, John Donahoe, said at that time: “This dividend increase reflects our continued confidence in our strategies to generate sustainable, profitable growth, while investing for the future.”
That statement caught my attention. To me, it sounded like what Donahoe was really saying was, “Please be patient while we figure out how to become more profitable.”
That hunch was proven correct on December 21 when Nike released its fiscal 2024 Q2 results. They weren’t bad, but they didn’t justify a premium multiple to earnings, either.
Even worse, the company’s wholesale revenues fell 2% during the quarter. If the top line isn’t growing, the only way to increase profits is to cut costs.
That’s what Nike did, effectively enough to increase its diluted earnings per share by 21%. In addition, the company stated that it “is identifying opportunities to deliver up to $2 billion in cumulative cost savings over the next three years.”
That may sound like good news to amateur investors. However, the pros on Wall Street know what that really means.
It is difficult for a business to gain market share while it is aggressively cutting costs. Especially while in the midst of a major corporate reorganization. That is what Nike will be doing over the remainder of this year.
According to the press release accompanying its Q2 results, “Areas of potential savings include simplifying our product assortment, increasing automation and use of technology, streamlining our organization, and leveraging our scale to drive greater efficiency.”
Nike said those measures are “expected to result in pre-tax restructuring charges of approximately $400 million to $450 million that will largely be recognized in the third quarter of fiscal year 2024, primarily associated with employee severance costs. Revised guidance will be provided on the conference call.”
That last sentence is what turned my options trade into a big winner. The last thing analysts want to hear is that a company will be decreasing its expectations for sales or profits.
The next day, Nike’s share price fell nearly 12%. Since then, it has fallen another 5% to return to where it was three months ago. Over the past twelve months, NKE is down nearly 20%. Over the same span, the S&P 500 Index is up by a similar amount.
That degree of underperformance won’t sit well with Nike’s institutional investors. Approximately 83% of its common stock is owned by mutual funds and professional portfolio managers.
They will wait to see if Nike can deliver on the promised cost savings. They will also want to know if those savings can be translated into profits.
If so, then it may not be long until Nike is once again on the upswing. But if those efforts fall short of expectations, we may see some changes in the C-suite at Nike later this year.
That is the type of stock market mayhem that can produce big profits if you know how to trade it. And right now, a see lot more mayhem in store for companies that can’t live up to Wall Street’s outsized expectations for them.
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