Investment Rating Buy shares At $84 Take Profits at $99 Stop Loss at $77 Pricing Closing Price

(10/20/06)

Nike
I. Screener Parameters The initial parameters used in selecting Nike Corporations stock were a large cap stock in the consumer discretionary industry. I chose consumer discretionary because the industry has been performing well and with interest rates stable as the nation approaches the holiday shopping season, the industry seems to be a good place to invest. To further reduce the options, I searched for a company with a beta of less than 1.5 and an ROE of more than 15 percent to meet Mizzou Investment Funds goals. Nike met all of these requirements and has a strong brand name and history. II. History and the Market Company Profile In 1962, Nike was born from a lie to future competitor, Onitsuka Tiger Company, later to become part of Asics. One of the future founders, Phil Knight, went to Onitsuka to convince the company that there was a market in America for low-priced athletic shoes from Japan. In order to be taken seriously, he made himself the owner of a fictitious company, Blue Ribbon Sports. Phil Knight and his former track coach, Bill Bowerman, start distributing Tiger running shoes out of their homes, under the Blue Ribbon name.1 Bowerman continued to work on new designs for shoes, and taking the swoosh as the logo for the new prototype, a soccer cleat, to be named Nike after the Greek goddess of victory. The shoe debuted in 1972 after a break in relations between Onitsuka and Blue Ribbon. With an increase in designs, many athletes are seen wearing Nikes at the 1976 Olympics, spurring the official name change in 1978.2 After Nikes initial public offering on December of 1980, the company gained a great deal of speed. By 1986, Nike had introduced Air Jordans, developed its apparel lines, and gave athletes endorsement contracts to serve as official spokesmen for the brand, starting with Michael Jordan and John McEnroe. From there, the company grew through acquisitions: Cole Haan Holdings in 1988, Bauer Brands for hockey in 1995, Hurley in 2002, Converse in 2003, and Starter Brands in 2004.3

$88.60 $91.54 $75.52

52-Week High 52-Week Low Valuation TTM

EPS P/E $5.14

17.50

Profitability & Effectiveness (ttm) ROA 13.96% ROE 21.94% Profit Margin 8.74% Op Margin 13.25% Gross Margin 44.00% Market Data Total Assets (as of 5/31/06) 9,869,600,000 Volume 1,519,700 Market Cap 22.71B Avg Vol
(3 month)

2,288,860 $5.14 17.50 1.05

EPS P/E PEG Div Yield 1.40%

Julia Hurst jmhzp5@mizzou.edu

1 2

http://www.nike.com/nikebiz/nikebiz.jhtml?page=50 http://www.nike.com/nikebiz/nikebiz.jhtml?page=50 3 http://www.nike.com/nikebiz/nikebiz.jhtml?page=50

Nike has been the center of political turmoil in the past. A brand that was started to bring affordable athletic shoes to the American population strayed from its ideals. By the 90s, Nike was notoriously one of the most expensive brands on the market. In the late 1990s, the corporation was one of several in the spotlight for using goods imported from sweat shops. Phil Knight, then CEO, announced that Nike would become a more transparent corporation and set standards for its manufacturing plants.4 Since then Nike has improved, ranking 13th in the United States for Best Corporate Citizens.5 In more recent years Nike has developed its market position with giving the consumer the ability to design his or her own shoe and accessories. Nike ID, originally a privilege reserved for celebrity clientele, allows the consumer to pick from several basic designs, change the colors and have his or her name on the product. The idea was launched in early 2004, revamped to be more user-friendly in March 2005, and gained acclaim, becoming Business Weeks Silver Award in 2005 for business ideas.6 Market Position Nikes market position is hard to determine, with many of its competitors being privately held. Most known for its athletic footwear, Nike competes with brands such as Adidas, which is publicly traded on the DAX, Reebok, acquired by Adidas last August7, and Asics, a group out of Tokyo, publicly traded on the Tokyo Stock Exchange.8 Adidas achieved significant growth in the last half of 2005 and beginning of 2006 leading up to and following the purchase of Reebok. However, it is apparent that the growth of the industry is cyclical, and that Adidass last down turn was significant enough to bring its percent of growth as close to Nike as it has been since early 2004 when Nike launched ID.

DAX
4 5

Nike

Adidas

Adidas.com

http://www.nike.com/nikebiz/nikebiz.jhtml?page=50 http://www.nike.com/nikebiz/nikebiz.jhtml?page=55&item=awards 6 http://images.businessweek.com/ss/05/06/idea2005/source/95.htm 7 http://www.press.adidas.com/en/Desktopdefault.aspx/tabid-28/ 8 http://www.asics.com/global/history.html

However, Nike is also known for its apparel, equipment and non-athletic shoes. In the segment of sports apparel, the corporation competes against Adidas, Puma, also not traded in the US, Under Armour Inc, which had its IPO November 18, 20059, and Champion Sports Wear, a privately held company. Nike and Under Armour both have historically out-performed the S & P. Under Armour, however, has out-performed Nike. Most of this growth comes from the principle that Nike is a stable company, where as Under Armour had just been introduced to the market as of less than a year ago.

Over the last two years, Nike has been facing the difficulties of becoming a stale brand. It has had a net positive growth over the time period, increasing earnings per share 18 percent in FY0610; however, the growth of the stock has fallen short of the growth of the S & P 500.

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http://www.uabiz.com/ http://www.nike.com/nikebiz/investors/annual_report/ar_06/docs/Phil_Knight_Letter.pdf

Looking at long term growth, though, Nike has out-performed the S & P 500 over the five year period, beginning October 2001. The corporation has grown nearly 75 percent while the S & P only achieved approximately 25 percent growth in the same period.

Additionally, maintains lower price ratios, including P/E, price to book, and price to free cash flow than the industry, sector and the S & P, signifying a more realistic and stable price.
Valuation Ratios Company P/E Ratio (TTM) P/E High - Last 5 Yrs. P/E Low - Last 5 Yrs. 17.63 27.50 14.99 Industry 19.08 27.59 13.83 Sector 18.36 32.54 13.13 S&P 500 20.62 37.57 14.36

Beta Price to Sales (TTM) Price to Book (MRQ) Price to Tangible Book (MRQ) Price to Cash Flow (TTM) Price to Free Cash Flow (TTM) % Owned Institutions
Reuters.com

0.58 1.49 3.73 3.99 13.95 23.03 61.10

0.77 1.75 3.81 4.25 15.74 23.46 65.84

1.12 1.33 3.42 7.26 12.10 24.08 55.06

1.00 2.90 3.97 6.92 14.64 30.65 68.60

Risks There has been a decrease in sales of all brands of athletic shoes in retail locations, like Finish Line, due to changing trends. 2006 has been a year of reshaping management, leaving some investors questioning the stability of Nike. Nike has been facing stronger competition from Adidas in both apparel and shoes after the competitor purchased Reebok in late 2005. Given the international presence of Nike, especially since 2006 was first year that international sales over-shadowed U.S. sales11, currency exchange risk poses a threat to profits. Foot Locker accounted for 10 percent of sales of Nike in the United States during fiscal year 200612, creating a risk of power of buyer and risks related to being significantly dependent on Foot Lockers future.

III. Valuation Researching Nike, betas from 0.53 to 0.88 were noted. I chose a beta of 0.73, listed on reuters.com because Nike does have some correlation to the market. The correlation is not perfect due to factors discussed under Risks and Impact of the Economy, however, given the corporations age and stability it is closer to one. Additionally, taking the average of the one year, three year and 5 year average growth rates for Nike, giving a 40 percent weight to the one year growth rate and 30 percent to the three and five year rates, the expected growth is 20.17 percent. Since Nike has been growing due to changes in supply chain management and internet sales recently, this number reflects an accelerated growth. An acceptable long-term growth for Nike will be 13 percent, which takes into account slowed excitement towards Nike ID, an increase of competition or alternatives, and decrease in benefits from effective supply chain management over time.

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http://www.nike.com/nikebiz/nikebiz http://www.nike.com/nikebiz/investors/annual_report/ar_06/docs/10k.pdf

Expected Return on Market = 8.5% Expected Stable Growth of Nike (per annum) = 13% Risk Free Rate = 4.8% Expected Accelerated Growth of Nike (per annum) = 20.17% Risk Premium = 3.7% RE = RF+ (Equity Risk Premium) 4.8 + 0.73 (3.7) = 7.50% discount rate.

Over the last year, Nikes dividends grew 24 percent, from $1.00 to $1.24. However, using the dividend discount model makes different assumptions, stable growth and perfect correlation with the market; assuming stable growth of 6 percent (inflation plus growth of the market) and a beta of one, Nike would appear to be overvalued by nearly 70 percent. DPS1/ (k g) = 1.24(1.06)/ ( 0.085 0.06) = 1.3144/0.025 = $52.58 This is not a reasonable number given Nikes current growth opportunities. Owner Earnings Model was chosen to give a second valuation. There are inherent problems with this model, however, when growth rates exceed the required return on equity. Since Nike has exceptional growth for a low risk stock, the model returns a negative number.
Owner Earnings in 2006: Net Income Depreciation Amortization Capital Expenditures Owner Earnings $ 1,392,000,000.00 $ 290,900,000.00 $ $ (333,700,000.00) $ 1,349,200,000.00 2006 $ 1,349,200,000.0 20.2% $ 1,621,333,640.0 $1,621,333,640.0 $28,159,654,229.8

Prior Year Owner Earnings First Stage Growth Rate (add) Owner Earnings Discounted Value per annum Sum of present value of owner earnings

Residual Value Owner Earnings in year 10 Second Stage Growth Rate (g) (add) Owner Earnings in year 11 Capitalization rate (k-g) Value at end of year 10 Present Value of Residual Intrinsic Value of Company

$ 8,472,994,885.2 13.00% $ 9,574,484,220.3 -5.50% ################# ################# #################

Shares outstanding assuming dilution Intrinsic Value per share

250710000 ($224.58)

Given the nature of Nikes growth, its required return on investment, and the intrinsic nature of valuation models, the best way, although least accurate, to estimate Nikes potential growth is to look at its current growth in stock price. Historical growth for the stock price has been 7.6 percent since October 2005. If the stock follows the same growth pattern, the stock should reach $97 in the next year. IV. Financials Nike has continued to increase its growth over the last several years. All though the cost of revenue and expenditures for general selling and administration has increased each year, attributed to the changes to Nike ID, innovations in design, research and development, and more locations added revenues have increased 8.8 percent from fiscal year 2005 to fiscal year 2006 and 22 percent from fiscal year 2004 to fiscal year 2006. Net income also rose each year; 28.1 percent from fiscal year 2004 to fiscal year 2005 and 14.9 percent from fiscal year 2005 to fiscal year 2006. Additionally, Nike has reported that revenues are up for the first quarter of fiscal year 2007 by 9 percent over 2006.13 Excerpts from Nike Income Statement
PERIOD ENDING

31-May-06 14,954,900 8,367,900

31-May-05 13,739,700 7,624,300

31-May-04 12,253,100 7,001,400

Total Revenue Cost of Revenue

Gross Profit

6,587,000

6,115,400

5,251,700

Operating Expenses Research Development Selling General and Administrative 4,477,800 4,221,700 3,702,000

Operating Income or Loss Net Income From Continuing Ops

2,109,200 1,392,000

1,893,700 1,211,600

1,549,700 945,600

Net Income

1,392,000

1,211,600

945,600

http://finance.yahoo.com

13

http://www.nike.com/nikebiz/investors/earnings/docs/q107.pdf

Nike has recently been decreasing its cash on hand and increasing short-term investments in capital expenditures. These investments include increased inventory holdings and pre-paid expenses.14

Excerpts from Nike Cash Flows

Investing Activities, Cash Flows Provided By or Used In Capital Expenditures Investments Other Cashflows from Investing Activities (333,700) (909,900) (33,000) (257,100) (35,300) (68,000) (213,900) (401,700) (330,900)

Total Cash Flows From Investing Activities

(1,276,600)

(360,400)

(946,500)

http://finance.yahoo.com

Earnings per share and dividends per share have also grown by double digit percentiles over the last five years. In the last year earnings have increased over 17 percent and dividends have increased 24 percent.
Growth Rates 1 Year Sales % EPS % Dividend %
Reuters.com

3 Years 11.82 24.03 29.77

5 Years 9.53 19.58 19.71

8.84 17.72 24.21

V. Impact of the Economy on the Industry There is a positive correlation between Nike Corporation and the economy. As part of the consumer discretionary industry, Nike is dependent on the consumers having spare income. When the economy is down, there is less demand for expensive foot wear or apparel; consumers are more likely to hold off on purchasing the non-necessities. The stock is also part of a cyclical industry. Consumer discretionary items are often purchased around the holidays in the later part of the year. This leaves Nike, whose fiscal year ends May 31st, experiencing higher growth in its second quarter and very low returns in its third quarter. Nike experiences some balance from its cyclicality by the nature of athletics; at the beginning of each fiscal quarter, a new sport season begins. Much of sale of athletic shoes and apparel come from high school and college sports, and with this comes the idea that new shoes are bought almost every season.

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http://www.nike.com/nikebiz/investors/annual_report/ar_06/docs/10k.pdf

VI. Current Events In the last two weeks, Nike has been hiring new upper management, causing some concern among investors. On October 4th, Larry Miller was named vice president and general manager of Nikes Basketball division and Peter Ruppe was named vice president and general manager of Mens Training and Fitness division following Nikes development of the new global positions in August of this year.15 On October 16th, Nike added another five global vice presidents: William Haitink was given the title of vice president and general manager of Nike China, Jim Godbout for Nike Japan, Davide Grasso as vice president of marketing for Asia Pacific, John Slusher for vice president of sports marketing in Asia Pacific and the Americas, and DeeDee Wilson for vice president of finance as well as CFO for Europe, Middle East and Africa.16 Additionally, Nike named Mark Duggan to the head of its Baurer hockey subsidiary, replacing Chris Zimmerman.17 On September 21st, Nike reported first quarter earnings of $1.47, a decrease of 9 percent from first quarter last year. Despite a growth in revenues of 9 percent, net income was also down 13 percent before stock option expenses. VII. Recommendations Currently, Nike is a good company but a bad stock to buy. Given Mizzou Investment Funds current position in the consumer discretionary industry, 16 percent of the total fund, as well as Nikes current price, I would recommend a holding position. The stock is not something its current holders should be selling, but given its cyclical nature, it is not something the Mizzou investment fund should buy at the moment. Instead, I recommend watching the stock; it is currently on a down tick and should be revisited when the stock drops below $84. At that point in Nikes business cycle, assuming an upward cap on Nike of approximately $97 over the next year (slightly below one year target estimate of $99)18, the fund would be able to realize a 16.7 percent return on the investment before commission fees. If the fund does decide to invest in Nike, I would recommend a take profits at $100. This is nearly a 20 percent return, but given the stocks growth rates, it is attainable. Nike is not likely to issue a stock split below $120, where its last split was in 1996.19 I would also recommend a stop loss price of $77 dollars, a 9 percent loss before commissions. This is not a very volatile stock, but if the corporation takes a down-turn, it will come out of it through its brand recognition and strong product line, so the fund should not shy away from a 5 percent loss. An additional recommendation after researching the industry is that further research be done on Under Armour (UARM). Despite a high P/E ratio, 93.4, and lower EPS, 0.497, the company has potential to grow as it reinvests the money from its first year as a publicly traded company.

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http://www.nike.com/nikebiz/news/pressrelease.jhtml?year=2006&month=10&letter=a http://biz.yahoo.com/ap/061016/apfn_nike_vps.html?.v=1 17 http://biz.yahoo.com/prnews/061012/sfth092.html?.v=45 18 http://finance.yahoo.com/q?s=nke 19 http://finance.yahoo.com/q/hp?s=NKE