Sold Cash Secured Put + Investment Thesis – Nike, Inc (NKE) – $57.00 strike – AUG 04 Expiration

This trade was actually executed on Tuesday 07/11/17. I didn’t get a chance to write about it until today.

I am now posting all my trades on the twitter. Be sure to follow @CatfishWizard on the twitter for the most up to date activity in the portfolio.

Since this is a new position, I need to outline my reasoning behind owning this stock.

Please visit the core philosophies article on my investment thesis process for a deeper explanation of the components of this article.

I have updated the portfolio and income tracker to reflect this position.

Dividend Cycle

NKE is due to go ex-div around September 1st which is about a month after this contract expires. The quarterly distribution is currently $0.18/share. I would expect that next upcoming dividend to be the last one at that level. NKE has made a habit of increasing the dividend in the fourth quarter. The company is a dividend contender boasting 15 consecutive years of increases.

The premium on this contract is the equivalent of 3 quarterly distributions at the current rate and is only in force for 24 days.

Investment

# contracts

Strike

Expiry

Total Premium

Days in Force

Ann. Return

Closing Price

Downside

1

$57

08/04/17

$54.20

24

14.46%

$58.18

2.03%

The QC (Quantitative Case)

Payout Ratio – EPS, FCF

28.69%, 40.88%

10 Year Revenue CAGR

9.83%

10 Year EPS CAGR (5 Year EPS CAGR)

19.58% (19.27%)

5 Year ave P/E – Current P/E (ttm)

+2.89

5 Year ave Yield – Current Yield  

-0.04%

10 year mean DGR (dividend growth rate)

14.7%

Debt/Market Cap

3.64%

Total Cash

$6.16B

Return on Assets

13.29%

Return on Equity

34.38%

Profit Margin

12.34%

EBITDA/Revenue

$5.45B/$34.35B (15.87%)

Reverse DDM Fair Value DGR at Strike

8.74%

Assumed DGR (DDM valuation 10% disc.)

8% by rule ($36.00)

DGR Margin of Safety

-0.74%

Dividend Cushion Ratio (8.76% DGR)

2.44

Cash from Ops “cushion”

-52.22%

Capex “cushion”

+209.3%

DGR “cushion” (delta)

+32%

SPL (Strike Price Logic)

The strike price was mostly related to what was available in the derivatives market at the time. That was about as much downside as was available with any reasonable kind of premium (I always aim for 12% annualized or better).

There was some weirdness going on around Amazon Prime Day, and it seemed like Mr. Market hated most any other company that sells stuff. So volatility was up in a relative sense, but a titan like NKE only gets so much premium.

I doubt that NKE is going to trade at a 2% or better yield any time soon, so the one weakness in my typical investment thesis process is that a DDM analysis is pretty much meaningless (without drastically increasing my discount rate).

A while back, when evaluating Visa, I used a quick and dirty discounted cash flow model using “free cash flow yield”. It’s not a bad way to get another perspective on stocks with extremely low yields.

For the trailing twelve months, NKE generated $1.76/share of FCF, which at the $57 strike “yields” 3.1%. So with a 10% discount rate, NKE only needs to grow FCF at 6.9% for that share price to be “fair”.

Considering they have grown FCF at a 14.1% annualized clip over the last 5 years, I think we’re gonna be alright.

 Qualitative Warm and Fuzzy (QWaF)

Nike has one of the strongest brand identities in the world. As long as people are buying yoga pants, and sneakers, Nike is likely to dominate the market share. Considering the middle class is growing rapidly in developing countries and emerging markets, the number of yoga pants and sneakers sold world-wide is not slowing down any time soon.

CPR (Cold and Prickly Risks)

Ostensibly the reason volatility picked up last week in specialty brands and retailers was that Amazon is changing the way people buy stuff. Some headlines I saw suggested that there were better “Prime Day” deals on competitive brands (like Under Armour I guess?), right after Nike finally capitulated and started working with the internet retail giant. 

Anyone and everyone who is in the business of selling “stuff”, specifically non staples, needs to adapt to the new way that people make purchasing decisions. There is always the risk with brands and retailers that they’re not going to adapt well, and then they go out of style.

Given management’s track record, I think those risks are pretty low in this case.

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