For the exclusive
use of R. Phillips, 2015.
UV0010
Rev. Jun. 29, 2015
Nike, Inc.: Cost of Capital
On July 5, 2001, Kimi Ford, a
portfolio manager at NorthPoint Group, a mutual fund management firm, pored
over analysts’ write-ups of Nike, Inc., the athletic-shoe manufacturer. Nike’s
share price had declined significantly from the beginning of the year. Ford was
considering buying some shares for the fund she managed, the NorthPoint
Large-Cap Fund, which invested mostly in Fortune 500 companies, with an
emphasis on value investing. Its top holdings included ExxonMobil, General
Motors, McDonald’s, 3M, and other large-cap, generally old-economy stocks.
Although the stock market had declined over the last 18 months, the NorthPoint
Large-Cap Fund had performed extremely well. In 2000, the fund earned a return
of 20.7%, even as the S&P 500 fell 10.1%. At the end of June 2001, the
fund’s year-to-date returns stood at 6.4% versus −7.3% for the S&P 500.
Only a week earlier, on June
28, 2001, Nike had held an analysts’ meeting to disclose its fiscal-year 2001
results.1 The
meeting, however, had another purpose: Nike management wanted to communicate a
strategy for revitalizing the company. Since 1997, its revenues had plateaued
at around $9 billion, while net income had fallen from almost $800 million to
$580 million (see Exhibit 1). Nike’s market share in U.S. athletic shoes
had fallen from 48%, in 1997, to 42% in 2000.2 In addition, recent supply-chain issues and the
adverse effect of a strong dollar had negatively affected revenue.
At the meeting, management
revealed plans to address both top -line growth and operating performance. To
boost revenue, the company would develop more athletic-shoe products in the
midpriced segment3—a segment
that Nike had overlooked in recent years. Nike also planned to push its apparel
line, which, under the recent leadership of industry veteran Mindy Grossman,4 had performed extremely well. On the cost side,
Nike would exert more effort on expense control. Finally, company executives
reiterated their long-term revenue-growth targets of 8% to 10% and
earnings-growth targets of above 15%.
Analysts’ reactions were
mixed. Some thought the financial targets were too aggressive; others saw
significant growth opportunities in apparel and in Nike’s international
businesses.
Ford read all the analysts’
reports that she could find about the June 28 meeting, but the reports gave her
no clear guidance: a Lehman Brothers report recommended a strong buy, while UBS
Warburg and CSFB analysts expressed misgivings about the company and
recommended a hold. Ford decided instead to develop her own discounted cash
flow forecast to come to a clearer conclusion.
1
Nike’s fiscal year ended in
May.
2 Douglas Robson, “Just Do…Something: Nike’s
Insularity and Foot-Dragging Have It Running in Place,” BusinessWeek (2
July 2001).
3 Sneakers in this segment sold for $70 to $90 a
pair.
4 Mindy Grossman joined Nike in September 2000.
She was the former president and chief executive of Jones Apparel Group’s Polo
Jeans division.
This case was
prepared from publicly available information by Jessica Chan, under the
supervision of Robert F. Bruner and with the assistance of Sean D. Carr. The
financial support of the Batten Institute is gratefully acknowledged. It was
written as a basis for class discussion rather than to illustrate
effective or
ineffective handling of an administrative situation. Copyright 2001 by the
University of Virginia Darden School Foundation, Charlottesville, VA. All
rights reserved. To order copies, send an e-mail to sales@dardenbusinesspublishing.com. No part of
this publication may be reproduced, stored in a retrieval system, used
in a spreadsheet, or transmitted in any form or by any means—electronic,
mechanical, photocopying, recording, or otherwise—without the permission of the
Darden School Foundation.
This document is
authorized for use only by Richard Phillips in FIN 587 Fall 2015-1 taught by
Matthew M. Wirgau, WALSH COLLEGE from November 2015 to December 2015.
For the exclusive
use of R. Phillips, 2015.
|
Page 2 |
UV0010 |
Her forecast showed that, at
a discount rate of 12%, Nike was overvalued at its current share price of
$42.09 (Exhibit 2). She had done a quick sensitivity analysis, however,
which revealed Nike was undervalued at discount rates below 11.17%.
Because she was about to go into a meeting, she asked her new assistant, Joanna
Cohen, to estimate Nike’s cost of capital.
Cohen immediately gathered
all the data she thought she might need (Exhibit 1 through Exhibit 4)
and began to work on her analysis. At the end of the day, Cohen submitted her
cost-of-capital estimate and a memo (Exhibit 5) explaining her
assumptions to Ford.
This document is
authorized for use only by Richard Phillips in FIN 587 Fall 2015-1 taught by
Matthew M. Wirgau, WALSH COLLEGE from November 2015 to December 2015.
For the exclusive
use of R. Phillips, 2015.
|
Page 3 |
UV0010 |
||||||||||||||
|
Exhibit |
|||||||||||||||
|
Nike, Inc.: Cost of Capital |
|||||||||||||||
|
Consolidated Income Statements |
|||||||||||||||
|
Year Ended May 31 |
1995 |
1996 |
1997 |
1998 |
1999 |
2000 |
2001 |
||||||||
|
(in millions of dollars except |
|||||||||||||||
|
Revenues |
$ |
4,760.8 |
$ |
6,470.6 |
$ |
9,186.5 |
$ |
9,553.1 |
$ |
8,776.9 |
$ |
8,995.1 |
$ |
9,488.8 |
|
|
Cost of goods sold |
2,865.3 |
3,906.7 |
5,503.0 |
6,065.5 |
5,493.5 |
5,403.8 |
5,784.9 |
||||||||
|
Gross profit |
1,895.6 |
2,563.9 |
3,683.5 |
3,487.6 |
3,283.4 |
3,591.3 |
3,703.9 |
||||||||
|
Selling and administrative |
1,209.8 |
1,588.6 |
2,303.7 |
2,623.8 |
2,426.6 |
2,606.4 |
2,689.7 |
||||||||
|
Operating income |
685.8 |
975.3 |
1,379.8 |
863.8 |
856.8 |
984.9 |
1,014.2 |
||||||||
|
Interest expense |
24.2 |
39.5 |
52.3 |
60.0 |
44.1 |
45.0 |
58.7 |
||||||||
|
Other expense, net |
11.7 |
36.7 |
32.3 |
20.9 |
21.5 |
23.2 |
34.1 |
||||||||
|
Restructuring charge, net |
– |
– |
– |
129.9 |
45.1 |
(2.5) |
– |
||||||||
|
Income before income |
649.9 |
899.1 |
1,295.2 |
653.0 |
746.1 |
919.2 |
921.4 |
||||||||
|
Income taxes |
250.2 |
345.9 |
499.4 |
253.4 |
294.7 |
340.1 |
331.7 |
||||||||
|
Net income |
$ |
399.7 |
$ |
553.2 |
$ |
795.8 |
$ |
399.6 |
$ |
451.4 |
$ |
579.1 |
$ |
589.7 |
|
|
Diluted earnings |
$ |
1.36 |
$ |
1.88 |
$ |
2.68 |
$ |
1.35 |
$ |
1.57 |
$ |
2.07 |
$ |
2.16 |
|
|
Average shares |
294.0 |
293.6 |
297.0 |
296.0 |
287.5 |
279.8 |
273.3 |
||||||||
|
Growth(%) |
|||||||||||||||
|
Revenue |
35.9 |
42.0 |
4.0 |
(8.1) |
2.5 |
5.5 |
|||||||||
|
Operating income |
42.2 |
41.5 |
(37.4) |
(0.8) |
15.0 |
3.0 |
|||||||||
|
Net income |
38.4 |
43.9 |
(49.8) |
13.0 |
28.3 |
1.8 |
|||||||||
|
Margins(%) |
|||||||||||||||
|
Gross margin |
39.6 |
40.1 |
36.5 |
37.4 |
39.9 |
39.0 |
|||||||||
|
Operating margin |
15.1 |
15.0 |
9.0 |
9.8 |
10.9 |
10.7 |
|||||||||
|
Net margin |
8.5 |
8.7 |
4.2 |
5.1 |
6.4 |
6.2 |
|||||||||
|
Effective tax rate (%)* |
38.5 |
38.6 |
38.8 |
39.5 |
37.0 |
36.0 |
*The U.S. statutory tax rate was 35%. The
state tax varied yearly from 2.5% to 3.5%.
Sources of data: Company filing with the
Securities and Exchange Commission (SEC), UBS Warburg.
This document is
authorized for use only by Richard Phillips in FIN 587 Fall 2015-1 taught by
Matthew M. Wirgau, WALSH COLLEGE from November 2015 to December 2015.
For the exclusive
use of R. Phillips, 2015.
|
Page 4 |
UV0010 |
||||||||||||||||||||||
|
Exhibit 2 |
|||||||||||||||||||||||
|
Nike, Inc.: Cost of Capital |
|||||||||||||||||||||||
|
Discounted |
|||||||||||||||||||||||
|
Assumptions: |
2002 |
2003 |
2004 |
2005 |
2006 |
2007 |
2008 |
2009 |
2010 |
2011 |
|||||||||||||
|
Revenue growth (%) |
7.0 |
6.5 |
6.5 |
6.5 |
6.0 |
6.0 |
6.0 |
6.0 |
6.0 |
6.0 |
|||||||||||||
|
COGS/sales (%) |
60.0 |
60.0 |
59.5 |
59.5 |
59.0 |
59.0 |
58.5 |
58.5 |
58.0 |
58.0 |
|||||||||||||
|
SG&A/sales (%) |
28.0 |
27.5 |
27.0 |
26.5 |
26.0 |
25.5 |
25.0 |
25.0 |
25.0 |
25.0 |
|||||||||||||
|
Tax rate (%) |
38.0 |
38.0 |
38.0 |
38.0 |
38.0 |
38.0 |
38.0 |
38.0 |
38.0 |
38.0 |
|||||||||||||
|
Current assets/sales (%) |
38.0 |
38.0 |
38.0 |
38.0 |
38.0 |
38.0 |
38.0 |
38.0 |
38.0 |
38.0 |
|||||||||||||
|
Current liabilities/sales (%) |
11.5 |
11.5 |
11.5 |
11.5 |
11.5 |
11.5 |
11.5 |
11.5 |
11.5 |
11.5 |
|||||||||||||
|
Yearly |
|||||||||||||||||||||||
|
Cost of capital (%) |
12.00 |
||||||||||||||||||||||
|
Terminal growth rate (%) |
3.00 |
||||||||||||||||||||||
|
Discounted Cash Flow |
|||||||||||||||||||||||
|
(in millions of |
|||||||||||||||||||||||
|
Operating income |
$ |
1,218.4 |
$ |
1,351.6 |
$ |
1,554.6 |
$ |
1,717.0 |
$ |
1,950.0 |
$ |
2,135.9 |
$ |
2,410.2 |
$ |
2,554.8 |
$ |
2,790.1 |
$ |
2,957.5 |
|||
|
Taxes |
463.0 |
513.6 |
590.8 |
652.5 |
741.0 |
811.7 |
915.9 |
970.8 |
1,060.2 |
1,123.9 |
|||||||||||||
|
NOPAT |
755.4 |
838.0 |
963.9 |
1,064.5 |
1,209.0 |
1,324.3 |
1,494.3 |
1,584.0 |
1,729.9 |
1,833.7 |
|||||||||||||
|
Capex, net of depreciation |
– |
– |
– |
– |
– |
– |
– |
– |
– |
– |
|||||||||||||
|
Change in NWC |
8.8 |
(174.9) |
(186.3) |
(198.4) |
(195.0) |
(206.7) |
(219.1) |
(232.3) |
(246.2) |
(261.0) |
|||||||||||||
|
Free cash flow |
764.1 |
663.1 |
777.6 |
866.2 |
1,014.0 |
1,117.6 |
1,275.2 |
1,351.7 |
1,483.7 |
1,572.7 |
|||||||||||||
|
Terminal value |
17,998.3 |
||||||||||||||||||||||
|
Total flows |
764.1 |
663.1 |
777.6 |
866.2 |
1,014.0 |
1,117.6 |
1,275.2 |
1,351.7 |
1,483.7 |
19,571.0 |
|||||||||||||
|
Present value of flows |
$ |
682.3 |
$ |
528.6 |
$ |
553.5 |
$ |
550.5 |
$ |
575.4 |
$ |
566.2 |
$ |
576.8 |
$ |
545.9 |
$ |
535.0 |
$ |
6,301.2 |
|||
|
Enterprise value |
$ |
11,415.4 |
|||||||||||||||||||||
|
Less: current |
1,296
|
