Anatomy on valuations discrepancies.

Anatomy on valuations discrepancies.

Union Footwear UF(15), management is doing a better overall job generating profit for shareholders than Nike. Yet Nike's stock is valued nine times more than UF. Come look at our evidence.

Here is an article first released to our subscriber on September 15th 1999 and now open for all to see.

During one of our e-mail discussions recently, Paul Renaud mused about the difference between P/E ratios in the US and Thailand. "Is Nike really worth 30 times earnings while Union Footwear is only worth four times earnings?", he asked. "After all, they are in the same business."

Differences in price/earning multiples between the SET and more developed markets certainly exist. Academic studies point to accounting rules, local interest rates, taxes, and currency expectations as the principal reasons.

But the interaction of these forces can also obscure the facts. Paul’s question is: On a company-by-company basis, are valuations really in line? In this article, we’ll examine the issue by comparing Nike and UF.

Nike Inc. (NYSE:NKE) is the world’s #1 brand marketer of athletic footwear. Nike products are sold in more than 100 countries. It controls 40% of the market in the U.S., alone.

Union Footwear Public Company (SET:UF) is a Thai manufacturer of athletic footwear. 80% of UF’s production is purchased by Nike.

Nike’s success in marketing its brand means success for UF. And UF’s efficiency in manufacturing a quality product at a competitive cost helps to ensure Nike’s success. So their fortunes are closely tied.

Which company represents the better value for investors?

Let’s start with a widely used measure of overall management performance: Return on Equity. We’ll use the most recent twelve months performance for each company to make the calculation.

This broad measure can best be analyzed by dividing it into three components: net profit margin (net income/sales), asset turnover (sales/assets) and financial leverage (assets/equity). Multiply the three together and we get ROE.

Net profit margin for the recent four quarters is nearly identical for the two companies, 5.1%.

Asset turnover at UF is 30% higher than Nike, coming in at 1.87 times versus 1.67 for Nike. UF Management is generating more sales on its asset base than Nike.

UF is slightly more leveraged than Nike, at 1.64 vs. 1.57, but the 4% difference is not significant. In fact, both companies are conservatively financed. UF’s debt to equity ratio is .16, compared to .24 for Nike. By way of comparison, Nike’s debt/equity ratio is about one quarter the average for S&P 500 companies.

Multiply the three factors together and we see the first result of our analysis: UF’s ROE comes in at 15.7% vs. 13.5% for Nike.

UF’s management is doing a better overall job of generating a profit for shareholders.

Growth is important. What can it tell us about these two companies? The five year compound annual growth in revenues using analyst estimates for the current year as the last period in the calculation – shows UF at 3.9% versus 18.3% for Nike. For the last three years, UF’s revenues have been growing at 10.6% vs. 13.9% for Nike.

Nike wins the top line growth category, but UF is showing increasing revenue growth while Nike has been slowing down.

Let’s get to the bottom line. How about compound annual growth in earnings per share (again using estimates for the current fiscal year as the last period)? Don’t we always hear that earnings growth ultimately drives stock prices?

Over the last five years, UF’s EPS shows annual compounded growth of 25.7% vs. 9.7% for Nike. For the last three years, UF’s EPS is growing 41% annually while Nike shows negative growth of 10%.

For earnings growth, UF has clearly been the better performer.

What about the cash return to shareholders? What’s the dividend yield? Based on analyst estimates of earnings for this year, and assuming last year’s dividend payout percentage, an investor who buys UF today can expect a 14.3% cash return. Nike? Considerably less, at about 1%.

Yes, that’s right. Buying UF today could yield a 14% annual return based on dividends, alone. That’s not counting potential appreciation in share price.

It appears that between the two companies, UF’s management is turning in a better performance for stockholders. So how are the shares priced relative to earnings? Price/Earnings ratios (trailing twelve months) are currently reported as follows: UF 4, Nike 32.

This brings Paul’s question into sharp focus. At the least, UF management is every bit as productive for shareholders as Nike management. What, then, is the justification for an investor who pays eight times more per dollar of earnings for Nike than for UF?As mentioned, there are other factors that an investor should consider. But the apparent imbalance in pricing of these two stocks relative to their performance bears careful consideration. The results of the analysis are summarized below. Thanks to Marketguide.com, Merrill Lynch, and I/B/E/S for data and estimates on Nike, and thanks to the SET and Wright Research Center for data and estimates on Union Footwear.

"TTM" means trailing twelve months.

Growth rates are calculated using geometric linking.

Value Holdings (Thailand) Co., Ltd.