Idea Transcript
NIKE Case Study Professor Corwin This case study includes several problems related to the valuation of Nike. We will work through these problems throughout the course to demonstrate some of the most important steps in a valuation from start to finish. The problems will be assigned individually as a component of your regular homework. However, please note that the solution from one problem may carry over as an important input on subsequent problems. You should therefore consider the case study not as a set of individual problems, but as one larger assignment that will be completed in steps. To solve the Nike problems, you will make use of Nike’s most recent financial statements as well as the notes to the financial statements. Nike's financial statements from the most recent fiscal year ending May 31, 2015 are included with this document. The notes to the financial statements and full 10K are available on the class web site.
An overview of the individual questions and their relation to the lecture topics is provided below. •
Question 1 – Financial Ratio Analysis (Lecture 1)
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Question 2 – Cost of Capital (Lecture 2)
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Question 3 – Operating Lease Adjustments (Lecture 3)
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Question 4 – Capitalization of Advertising Expenses (Lecture 3)
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Question 5 – Taxes (Lecture 3)
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Question 6 – Estimating Cash Flows (Lecture 3)
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Question 7 – Fundamental Growth in Earnings (Lecture 4)
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Question 8 – Cash Flow Discounting and Stock Price Estimation (Lecture 5)
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Question 9 – Relative Valuation (Lecture 6)
1. Financial Ratio Analysis a. Using Nike's financial statements and any additional resources that are necessary, calculate the profitability ratios we discussed in class (ROC, ROE, After-tax Operating Profit Margin, Net Profit Margin). Compare these ratios to those we calculated in class for Home Depot and note any important similarities/differences between the two firms. For the purposes of this assignment, we will assume that Nike and Home Depot are comparable firms.
b. Show the decomposition of Nike’s Return on Capital (ROC) into After-tax Operating Margin and Capital Turnover. Show the decomposition of Nike’s Return on Equity (ROE) into Net Profit Margin, Capital Turnover, and Financial Leverage. What do these decompositions suggest about the performance of Nike relative to Home Depot's performance, as discussed in class?
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2. Cost of Capital In this problem, you will calculate the cost of equity and weighted average cost of capital for Nike as of May 31, 2015. Be sure to explain any assumptions you make to arrive at your answers. a. Collect monthly return data for both Nike and the S&P 500 Index for the 60-month period ending in May 2015. Using this data, estimate the Beta for Nike based on a market model (CAPM) regression. Using this Beta estimate, calculate the cost of equity (Ke) for Nike based on the CAPM model. Note that you must choose an appropriate risk-free rate and market risk premium to use in the CAPM equation. Briefly explain your choice for each of these variables.
b. Assume that the value of Nike’s operating lease debt is $2,604 million and the firm’s employee stock options have an after-tax value of $2,398 million. Estimate the market value of debt and the market value of equity for Nike as of May 31, 2015. Nike has an AA- debt rating from S&P and an A1 (A+) rating from Moody’s. Use this information along with the default spreads provided in the course notes to estimate the firm's cost of debt (Kd). Using these estimates and your answer to (a), calculate the weighted average cost of capital (WACC) for Nike. Assume a marginal tax rate of 20.2%.
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3. Operating Lease Adjustments Using Nike’s most recent 10K, identify the firm’s future operating lease commitments and the amount the firm paid in operating lease (rental) expenses for the most recent fiscal year. Use this information to answer the questions below. a) In Case Study Question (2), we found the cost of debt for Nike to be 2.97%. Using this cost of debt, calculate the value of Nike’s operating lease debt and operating lease assets as of May 31, 2015 (the end of Nike’s fiscal year). Use these values and any necessary information from Nike's financial statements to estimate the adjusted book values of debt and assets for Nike.
b) Using your answers from prior questions and any necessary information from Nike's financial statements, calculate the values of after-tax operating income and Net Income in the most recent fiscal year, both before and after adjusting for operating leases. Assume a marginal tax rate of 20.2%.
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4. Capitalization of Advertising Although Nike’s R&D expenses are limited, the firm invests heavily in advertising and other promotional expenses. Because you believe these expenses create benefits that accrue to the firm over multiple periods, you decide to capitalize these expenses in your valuation of Nike. Total advertising expenses for Nike in each of the past six fiscal years are listed below. Use this information to answer the subsequent questions.
Year 2011 2012 2013 2014 2015
Advertising Expense ($ millions) 2,344.0 2,607.0 2,745.0 3,031.0 3,213.0
a) Assuming a three-year life for advertising, calculate the Advertising Amortization for Nike in the most recent fiscal year and the unamortized value of Nike's Advertising asset at the end of the fiscal year (May 31, 2015). Use your answers and any necessary information from Nike's financial statements to calculate the adjusted book values of equity and assets.
b) Using your answer above and any necessary information from Nike's financial statements, calculate the value of after-tax operating income and Net Income for Nike in the most recent fiscal year after adjusting for the both operating lease and the capitalization of Advertising.
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5. Taxes Using your answers from prior questions and any necessary information from Nike's financial statements, answer the following questions about Nike’s taxes. a) Calculate Nike's effective tax and marginal tax rates for the fiscal year ending May 31, 2015.
b) McKinsey & Co. recommend estimating the taxes actually paid on the operating income of the firm. They refer to this as operating cash taxes. Estimate the operating cash taxes for Nike in the most recent fiscal year using the following steps: (1) start with reported taxes, (2) subtract the taxes paid on non-operating income, (3) add back the tax shield related to interest expenses on the firm's debt (including debt listed on the balance sheet and operating lease debt), and (4) subtract (add) any increase (decrease) in net deferred tax liabilities. For steps (2) and (3), estimate the tax adjustments using a marginal tax rate of 20.2%.
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6. Estimating Cash Flows Using your answers from prior questions and any necessary information from Nike's financial statements, answer the following questions about Nike’s cash flows in the most recent fiscal year. a) Calculate FCFF for Nike in the most recent fiscal year.
b) Calculate FCFE for Nike in the most recent fiscal year. Note that this calculation requires you to use the cash flow statement to determine the firm’s net debt issues during the year.
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7. Fundamental Growth in Earnings Using your answers from prior questions and any necessary information from Nike's financial statements, answer the following questions about fundamental growth in earnings for Nike. Note that most of the information you need to answer these questions can be found in the prior solutions. a) Using the fundamental growth formulas we discussed in class and assuming the ROC will remain constant, estimate the expected growth in EBIT for Nike in the coming year. Be sure to incorporate any necessary adjustments made in prior assignments (for example, adjustments for one-time charges, operating leases, capitalization of advertising, etc.). How does your estimate of future growth compare to the firms actual growth in EBIT over the previous year?
b) Using the fundamental growth formulas we discussed in class and assuming the ROE will remain constant, estimate the expected growth in Net Income for Nike in the coming year. Be sure to incorporate any necessary adjustments made in prior assignments (for example, adjustments for one-time charges, capitalization of advertising, etc.). How does your estimate of future growth compare to the firms actual growth in Net Income over the previous year?
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8. Cash Flow Discounting and Stock Price Estimation a) To perform a discounted cash flow analysis for Nike, begin with your Free Cash Flow to the Firm (FCFF) estimate from Case Study Question (6a). This value will represent your year zero cash flow estimate. Based on the fundamental growth estimates from Case Study Question (7), you forecast that this cash flow will grow at 6.0% in year one, with the growth rate decreasing by 0.7% per year until it stabilizes at 2.5% in year six. Based on these forecasts and your cost of capital (WACC) estimate from Case Study Question (2), estimate the present value of FCFF for Nike. Show your work on a separate page if necessary.
b) As of May 31, 2015, Nike's shares outstanding include 178 million class A shares and 679 million class B shares. In addition, Nike's stock was trading at a price of $101.67, the firm's marginal tax rate was 20.2%, and the yield on 10-year treasuries was 2.17%. Use this information, along with any necessary information from the firm's financial statements (and notes to the financial statements) to estimate the value of Nike's outstanding employee stock options as of May 31, 2015. Attach a printout of the spreadsheet or other option pricing model used to calculate the option price.
c) Nike has no minority interests or majority active holdings, but does have other long-term nonoperating assets (i.e., investments) and liabilities. Using your answers to (a) and (b) above, along with any other necessary information from the firm's financial statements, estimate the per share value of Nike's stock (Note: you can assume that class A and B shares are identical).
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9. Relative Valuation a) Nike’s stock price and shares outstanding as of May 31, 2015 were $101.67 and 857 million. Calculate the P/E ratio for Nike based on this information and the EPS from the most recent fiscal year. Recalculate an adjusted version of the P/E ratio by dividing the current market value of equity by the net income from the most recent fiscal year, incorporating all appropriate adjustments (Note that all of the information you need to complete these calculations is contained in the previous homework solutions). How did the ratio change after incorporating the adjustments and why?
b) Using information from the end of Nike’s most recent fiscal year (May 31, 2015), calculate the Enterprise Value to EBITDA ratio for Nike. Recalculate an adjusted version of the ratio, incorporating all appropriate adjustments (Note that all of the information you need to complete these calculations is contained in the previous homework solutions). How did the ratio change after incorporating the adjustments and why?
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PART II
NIKE, Inc. Consolidated Statements of Income
Income from continuing operations: Revenues Cost of sales Gross profit Demand creation expense Operating overhead expense Total selling and administrative expense Interest expense (income), net (Notes 6, 7 and 8) Other (income) expense, net (Note 17) Income before income taxes Income tax expense (Note 9) NET INCOME FROM CONTINUING OPERATIONS NET INCOME FROM DISCONTINUED OPERATIONS NET INCOME Earnings per common share from continuing operations: Basic (Notes 1 and 12) Diluted (Notes 1 and 12) Earnings per common share from discontinued operations: Basic (Notes 1 and 12) Diluted (Notes 1 and 12) Dividends declared per common share
$
Year Ended May 31, 2014
2013
$
30,601 $ 16,534 14,067 3,213 6,679 9,892 28 (58) 4,205 932 3,273 — 3,273 $
27,799 $ 15,353 12,446 3,031 5,735 8,766 33 103 3,544 851 2,693 — 2,693 $
25,313 14,279 11,034 2,745 5,051 7,796 (3) (15) 3,256 805 2,451 21 2,472
$ $
3.80 $ 3.70 $
3.05 $ 2.97 $
2.74 2.68
$ $ $
— $ — $ 1.08 $
— $ — $ 0.93 $
0.02 0.02 0.81
FORM 10-K
2015
(In millions, except per share data)
The accompanying Notes to the Consolidated Financial Statements are an integral part of this statement.
NIKE, INC.
2015 Annual Report and Notice of Annual Meeting
107
PART II
NIKE, Inc. Consolidated Balance Sheets May 31,
ASSETS Current assets: Cash and equivalents (Note 6) Short-term investments (Note 6) Accounts receivable, net (Note 1) Inventories (Notes 1 and 2) Deferred income taxes (Note 9) Prepaid expenses and other current assets (Notes 6 and 17) Total current assets Property, plant and equipment, net (Note 3) Identifiable intangible assets, net (Note 4) Goodwill (Note 4) Deferred income taxes and other assets (Notes 6, 9 and 17) TOTAL ASSETS LIABILITIES AND SHAREHOLDERS’ EQUITY Current liabilities: Current portion of long-term debt (Note 8) Notes payable (Note 7) Accounts payable (Note 7) Accrued liabilities (Notes 5, 6 and 17) Income taxes payable (Note 9) Total current liabilities Long-term debt (Note 8) Deferred income taxes and other liabilities (Notes 6, 9, 13 and 17) Commitments and contingencies (Note 16) Redeemable preferred stock (Note 10) Shareholders’ equity: Common stock at stated value (Note 11): Class A convertible — 178 and 178 shares outstanding Class B — 679 and 692 shares outstanding Capital in excess of stated value Accumulated other comprehensive income (Note 14) Retained earnings Total shareholders’ equity TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
$
$
2014
3,852 $ 2,072 3,358 4,337 389 1,968 15,976 3,011 281 131 2,201 21,600 $
2,220 2,922 3,434 3,947 355 818 13,696 2,834 282 131 1,651 18,594
107 $ 74 2,131 3,951 71 6,334 1,079 1,480
7 167 1,930 2,491 432 5,027 1,199 1,544
—
$
— 3 6,773 1,246 4,685 12,707 21,600 $
FORM 10-K
2015
(In millions)
—
— 3 5,865 85 4,871 10,824 18,594
The accompanying Notes to the Consolidated Financial Statements are an integral part of this statement.
NIKE, INC.
2015 Annual Report and Notice of Annual Meeting
109
PART II
NIKE, Inc. Consolidated Statements of Cash Flows 2015
(In millions)
Cash provided by operations: Net income Income charges (credits) not affecting cash: Depreciation Deferred income taxes Stock-based compensation (Note 11) Amortization and other Net foreign currency adjustments Net gain on divestitures Changes in certain working capital components and other assets and liabilities: (Increase) decrease in accounts receivable (Increase) in inventories (Increase) in prepaid expenses and other current assets Increase in accounts payable, accrued liabilities and income taxes payable Cash provided by operations Cash used by investing activities: Purchases of short-term investments Maturities of short-term investments Sales of short-term investments Investments in reverse repurchase agreements Additions to property, plant and equipment Disposals of property, plant and equipment Proceeds from divestitures (Increase) in other assets, net of other liabilities Cash used by investing activities Cash used by financing activities: Net proceeds from long-term debt issuance Long-term debt payments, including current portion (Decrease) increase in notes payable Payments on capital lease obligations Proceeds from exercise of stock options and other stock issuances Excess tax benefits from share-based payment arrangements Repurchase of common stock Dividends — common and preferred Cash used by financing activities Effect of exchange rate changes on cash and equivalents Net increase (decrease) in cash and equivalents Cash and equivalents, beginning of year CASH AND EQUIVALENTS, END OF YEAR Supplemental disclosure of cash flow information: Cash paid during the year for: Interest, net of capitalized interest Income taxes Non-cash additions to property, plant and equipment Dividends declared and not paid The accompanying Notes to the Consolidated Financial Statements are an integral part of this statement.
110
$
$
$
Year Ended May 31, 2014
3,273 $
2,693 $
2013
2,472
606 (113) 191 43 424 —
518 (11) 177 68 56 —
438 20 174 64 66 (124)
(216) (621) (144) 1,237 4,680
(298) (505) (210) 525 3,013
142 (219) (28) 27 3,032
(4,936) 3,655 2,216 (150) (963) 3 — — (175)
(5,386) 3,932 1,126 — (880) 3 — (2) (1,207)
(4,133) 1,663 1,330 — (598) 14 786 (2) (940)
— (7) (63) (19) 514 218 (2,534) (899) (2,790) (83) 1,632 2,220 3,852 $
— (60) 75 (17) 383 132 (2,628) (799) (2,914) (9) (1,117) 3,337 2,220 $
986 (49) 10 — 313 72 (1,674) (703) (1,045) 36 1,083 2,254 3,337
53 $ 1,262 206 240
53 $ 856 167 209
20 702 137 188