Nike at Its Declining Phase - Case Study Example

Case Study Finance Introduction NIKE, Inc. is an American based multinational corporation which is involved in the design, manufacture and marketing as well as sale of footwear, accessories, equipments, clothing and distribution of services to women, men and kids globally. The company provides commodities in seven classes inclusive of NIKE sportswear under the branding of Jordan and NIKE, men’s training, action sports, running, basketball and football. Moreover, the firm markets goods created for children and other recreational and athletic purposes like cricket, golf, baseball, football, volleyball, wrestling, walking and outdoor activities. The firm provides equipment for performance inclusive of sport balls, socks, timepieces, bats, eyewear, golf clubs, protective equipment among others. Currently, the company is at its declining phase given that in spite of achieving global recognition, their sales are declining, the market share is declining and the profits are not growing. Moreover the share price of the company’s stocks is going down the drain and there are concerns over its investment in mutual fund where the rating of the company is slowly being lowered. Definition of Problem In July 2005 a portfolio manager of the company noted that a mutual fund management company was concerned over the write-ups of the groups. As a result the security prices of the firm continued to decline considerably. The company was also noted to be investing much in shares of fortune 500 firms which emphasis on value investment. Whilst the stocks were declining, the North Point Large-cap Fund was doing well as noted from its return of 20.7% while the rating by Standard and Poor went down 10.1%. There were also concerns over the profits remaining constant at US$ 9 billion while the market share in athletic shoes went down to 42% in 2000 from 48% in 1997. Revenue was also adversely affected by the negative impact of the dollar currency. Analysis To boost the revenues and growth of the company has to deal with top notch operating performance and establish strategies to boost the sale of athletic shoes in the mid-priced market segment which a segment the company has neglected in the recent times. The company has to also extend its efforts to clothing line business where the under the latest management the firm has performed well. Moreover, on the cost side of the company the company has plans to increase its efforts on control of expenses. The meeting of top executives stressed the importance of having a target of long term increase in revenues of 10% and a 15% growth in earnings. The technical analysis of NIKE common stock Source: (Yahoo Finance 1) Moreover the analysts draw plenty of mixed reactions from the top executives’ proposed targets. Some are of the opinion that the financial estimates set by the executives are too ambitious while other have seen possible considerable growth in the line of apparel of the company based on the global business operations. While some analysts proposed the company should sell its shares, others think the company should hold on its investment while others think it would be prudent if the company discounted its cash flows. A discount rate of 12% would end up overvaluing the present share price of $ 42.09 but through sensitivity analysis NIKE is under valued at a discount of approximately 11.17%. Cost of equity To estimate the Weighted Average Cost of Capital of NIKE using the CAPM (Capital Asset Pricing Model), the company will be able to find the best value to grow its equity without under valuing or over valuing its value. Therefore assumption can be made that the company uses a cost of equity of about 11% and using the current yield on a 10 year treasury bond as the risk free rate (5.39%) for the company. Moreover the beta used for the company is assumed to be the average of the betas from the year 1996 to 2001 which is 0.8. Hence in putting in the CAPM model formula; WACC = Kd (1-t) x D/(D +E) + Ke x E/(D + E) or Ra = rf + β (rm - rf) = 5.39+ 0.8(11-5.39) 9.878% The company should an expected rate of return at 9.878% for the share price value not to be too ambitious or rather aggressive. Other assumptions made to get the 9.878% entailed use one cost of capital for whole firm. Taking multiple costs of capital would only complicate the computation of the costs of capital. Since NIKE is involved in numerous business divisions this cannot be the rationality to use different cost of capital given that the outcome will be reported using one financial report for the entire group. The company makes about 62% of its revenue from footwear, 30% from apparel which accolades the footwear. 3.6% of the revenue is accounted for in equipments while the rest of the revenue is accounted for through brands not related to the company. Therefore with the exception of Cole Haan, the rest of the business segments are related sporting activities which then helps in coming to a conclusion that they are all exposed to similar risks. Given that the company ‘s capital structure comprise of equity and debt financing WACC can be used based on the recent balance sheet dated May 21st, 2001 (Yahoo Finance 1). Taking total debts as a fraction of total capital for 2001 the figure is; Current portion of long term debt $ 50.1 million Notes payable 924.2 million Long term debt 470.3 million Total debt $ 1.4446 billion Total equity is 3.316 billion Total capital is $ 4.7606 billion hence debt as a percentage of total capital equals 30% while equity is equal to 70%. As the cost of debt of 4.28% which is approximately 4.3% the total interest expense for 2001 will be taken and then divided by the average debt balance of the company. It is notable that the rate is much inferior compared to the Treasury yield which is attributed to the company’s raising most of its financing needs via foreign currency. Alternative Solutions Other available solutions for the company entail the company stepping up on its promotional activities. The company has been noted to concentrate much on footwear and sportswear, it is a high time the company stopped neglecting the apparel wear. The apparel is currently a lucrative business segment when tapped in the right design and manner. Therefore, putting much focus on marketing and sale of apparel as it is done on the footwear and sportswear, the division is likely to increase the current revenue by a figure of about 21% to 26.5%. This is considering the fact that NIKE is a globally reputable firm that has supported various sporting activities in the world hence it will not be too much for the company to do in marketing apparel. The standard and Poor’s credit rating reduces when the investment in bonds and shares loses its value. The growth in share price represents the growth in the shareholder’s wealth which is also closely related to the growth in profitability of the company. The best the company can do is to minimize on the unnecessary expenses or costs which can be avoided. With the growth in revenue minimization of costs comes the growth of net income and possible announcement or declaration of dividends for the investors. However, caution must be taken to avoid destroying the value of the products which might taint the long-standing reputation of the company. Recommendations In view of the above analysis it will be prudent for the company to take on various recommendations drawn from the analysis of this exercise. First and foremost, the company must take into account that setting very high targets for the company will only strain the available resources which would then result into compromising of quality. Therefore reasonable targets must be determined for example setting a target of 9.878 for the estimated return rate. Of major importance to the company, is the investment in apparel line of business. The company can use its capital base to diversify into emerging markets such as China, Brazil and developing nations in Africa. China and Brazil are noted to be among the most upcoming markets for different products basically due to the high population in the countries. Specifically, if the company can draw its attention to manufacture and branding of apparel and exporting them to the developing markets where the middle income earners are in large population. The tradition of only focusing on the high end customers such as sponsoring big tournaments and clubs must come to an end. The current market calls for compromise of the business operations given that segmenting of the market based on income with the increasing pressure from inflation in different countries will only strain the sale revenue of the company. The main issue as noted was a stagnated profit and sales revenue of the business which shows a reduction in the market share of the firm. This has been attributed to the fact that the company does not wish to extend its operation to the lower level markets such middle income earning population. This can be done if NIKE produces products with different quality to suit the market in which they are being sold. Work cited Yahoo Finance. Nike Inc. Yahoo Finance. 2005. Internet source. Read More