TMF Ralegh Shows
Us the Value
by Dale Wettlaufer
(TMF Ralegh)
The Players
Since Tom Gardner has taken shots at Nike's business model, I'm lifting some
of what I originally wrote on our Nike message board on the web. What I want
to do here is compare Nike to COCA-COLA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KO)") else Response.Write("(NYSE: KO)") end if %> and GILLETTE
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: G)") else Response.Write("(NYSE: G)") end if %>, two companies with which Tom has fallen deeply in love (or like).
These two companies are also favored by Warren Buffett, who calls them
"The
Inevitables."
While I don't expect Nike to perform as well as Coke because of the sheer
cash-generating power of that company, its ultra-thin business model, and
tremendous brand equity built over a century, I do expect that Nike will
approach these measures. Nike is in the same sort of business as Coke and
Gillette. They all make consumable goods, their success depends upon building
and maintaining a brand, and their brands and successes are all able to be
duplicated abroad. So let's look at these companies emphasizing asset management.
First of all, a note on Nike's excellent control over its distribution channel.
Nike's distribution is as about as tight as you can make a consumer
goods-oriented business. Its innovative Futures program, under which a retailer
puts in a non-cancelable order months ahead of scheduled delivery, removes
a good deal of inventory risk from Nike. Originally, Nike dreamed up the
Futures program to finance its inventory needs. Now, though, it makes for
a highly efficient global business model. The concept is directly parallel
to commodities futures in that it helps the producer forecast demand and
the buyer assure supply. Just as commodities futures markets create efficiency
in the production and distribution of goods such as lumber and orange juice,
Nike knows exactly what it needs to produce, as just under 90% of U.S. footwear
is ordered under the Futures program.
Inventory and Cash Management
Let's see exactly what the inventory needs of our companies are. Here, we
look at average yearly inventory divided into sales:
Nike 11.2%
Gillette 14.5%
Coke 5.6%
On cash management, let's look at the numbers. What you see here is
cash/annualized operating expenses.
Nike 19.4%
Gillette 0.84%
Coke 8.9%
While it looks like Nike retains enough cash to remain flexible, Gillette
looks a little thin. That's probably the result of good asset management,
though. After all, a company like Gillette runs on a bunch of standard components
whereas Nike's products are a heck of a lot more diversified. Gillette's
low level is due to it free cash flow situation. Looking at its cash flow
statement, I don't see any share repurchases and I also see more capital
expenditures being made than depreciation and amortization. Nike pays out
dividends of more than $60 million per year and has bought back almost $300
million in stock in the last three years. Of course, Coke rules in the share
buyback department, yet it still retains cash on the books to steer such
a large global enterprise at its pleasure, and not that of its bankers.
Accounts Receivable Management
As for accounts receivable/annualized sales, one would expect that Gillette
and Nike would show a similar profile since they are both in the consumer
products business. Let's go to the replay, Tom:
Nike 17.8%
Gillette 22.4%
Coke 9.0%
Now let's look at accounts receivable days sales outstanding (DSO) as of
the most recent reports:
Nike 70.6
Gillette 90.5
Coke 37.9
By the way, while compiling the last set of data, I see that Gillette sells
about $23 million worth of goods a day, Nike sells on average $26 million
a day, and Coke's average daily revenues are in the range of $45 million
(please see note below).
Even with a huge network of retail distribution that it serves, Nike's number
is better. Gillette's number is larger, which is one reason it doesn't have
the cash cushion that Nike has. Coke, with its bottling network, knows exactly
who's paying whom and when, and thus runs the leanest business.
Return on Invested Capital
Let's look at these businesses in another way, considering return on invested
capital (ROIC). ROIC is defined as: total assets minus non-interest bearing
current liabilities minus cash (invested capital) divided by after tax operating
income. The denominator in the equation is average invested capital, so we
would want to take the invested capital amount at the beginning of the year
and average that with the amount of invested capital at the end of the year.
ROIC shows the return a company is able to generate on the operating assets
(such as its plant and inventory) devoted to a business, minus its cash and
minus the financing that is provided by suppliers and employees (which shows
up in liability accounts such as payables and accrued expenses).
Return on invested capital for our peer group is as follows:
Nike 22.4%
Gillette 20%
Coke 34.6%
Coke has an extremely low tax rate, which necessarily increases ROIC. At
a normal tax rate, the ROIC would descend into the under 30% range, but that's
also the beauty of having an international brand.
As for current valuations, Coke is it! I could spend time talking about how
great Coke is or I could descend into the popular argument of how overvalued
Coke is. I'll leave that to you, but I also would like to point out what
the valuation looks like on Nike going forward in light of the numbers laid
out above.
1998 EPS Estimate Multiple to Estimated EPS
Coke $1.93 37
Nike $3.20 19
Gillette $3.08 31
Show Me the Value
Looking at Tom's love, Gillette, I don't see any superiority. In fact, I
would think about financing a long position in Nike with a short in Gillette.
Furthermore, I'll bet Tom $10 that Nike outperforms Gillette over the next
two years (the same bet we have with Nike versus Intel), starting from today's
closing prices. Before I take my leave on these comparisons, I would also
highly recommend Randy Befumo's
series on Return on
Equity. Looking at the different components of ROE, I think you can take
the above comparisons even further in evaluating where value lies in "The
Inevitables" and a potential candidate for that pantheon.
Note: Most of Gillette's numbers were taken from fiscal 1995 because of the
lack of a full year of doing business with the acquired Duracell business.
The comparison is meant to look at business models and not necessarily the
exact operating numbers. The rest of the numbers come from Nike's and Coke's
most recent complete fiscal years.
On to Lesson # 3 -- Run the
Marathon, not the Dash |