Nike — How to Play Thursday’s Earnings Report

Sports apparel company Nike (NYSE: NKE ) reports earnings for the quarter
ending Aug. 31, 2011, on Thursday after the market closes. Retail stocks are
rebounding nicely in September, but weak guidance from Lululemon (NASDAQ: LULU )
might foreshadow trouble for Nike. The market clearly is uncomfortable at
current levels. One week we go up, only to retest the lows the next week. The
bears are expecting a significant slowdown in the economy. The bulls believe we
have seen the worst of it. Who will be right? With third-quarter earnings season
set to begin in early October, we will soon find out. In the interim, a handful
of companies Nike among them are reporting results that will give us clues as
to the future direction of the market. Nike has exceeded Wall Street estimates
in three of the past four quarters: When Nike reported results for the quarter
ending May 31, shares soared . The glowing report did include a warning that
higher manufacturing costs would eat into future profits into 2012. With the
warning, analysts reduced guidance for the current quarter. The average Wall
Street estimate is for Nike to make $1.21 per share. That number is eight cents
lower than the $1.29 per share estimate 90 days ago. For the full year ending
May 31, 2012, the company is expected to make $4.83 per share. In the last
fiscal year, Nike made a profit of $4.17 per share. At current prices, NKE
shares trade for 22 times trailing earnings and 19 times forward earnings. The
expected year-over-year profit growth rate is 16%. Given the strong operating
performance during the past year, it should be no surprise that shares of Nike
have gained 16%: Nike's earnings report comes at a time when the market is in
rally mode. During the past week, stocks have gained impressively, with the only
blip coming on Monday. Shares of Nike have participated in the rally, with
shares spiking to above $90 per share. Those gains have Nike at a premium
valuation relative to its expected growth rate. Using Lululemon's reduced
guidance as a guide, it would be surprising to see Nike be anything but cautious
in the current report. The company previously suggested profit margins would be
hit by higher manufacturing costs. Will the strong brand equity in the Swoosh be
enough to propel shares higher from here? At the time Lululemon reported its
results on Sept. 8, shares traded for 50 times current-year estimates, with
expected profit growth of 27%. The reduction in earnings pierced the bubble
somewhat, but shares now trade well above pre-earnings levels thanks to a rally
in stocks. Nike trades for a much more reasonable valuation. Current quarter
estimates have been sliced, setting the table for an earnings beat on Thursday.
A particularly strong report could impress investors to the point of pushing
shares up 5% or more. Other companies reporting results this week include Finish
Line (NASDAQ: FINL ) and KB Home (NYSE: KBH ).