Of course, with the global economic slowdown recent sales growth hasn’t been nearly so good, and a recent increase in inventory, and the commensurate markdowns needed to clear them, has pressured margins somewhat.
However, that hardly seems to justify the market’s overreaction over the past year. That’s because of several key positive factors that Wall Street is currently overlooking.
First, keep in mind that Nike’s brand strength remains as robust as ever, thanks to it having honed athlete endorsements down to a science, as seen with the decade’s long premium pricing power of the Air Jordan brand.
Second, international growth, especially in developing markets, gives the company a very long growth runway. For example, in the last quarter constant currency sales growth in China, Japan, and Emerging Markets came in at 21%, 18%, and 11%, respectively. That’s especially true given that the global sports apparel and footwear industry is estimated to be over $270 billion in size, meaning that Nike’s overall market share is less than 15%.
Third, some of the increase in inventory is due to Nike executing extremely well in its direct-to-consumer, or DTC efforts, especially with sales through Nike.com. For example, DTC and NIKE.com sales in the fiscal Q1 were up 22% and 49%, respectively; far higher than retail sales in any of its international markets. Nike’s e-commerce business is a little over $1 billion and is expected to grow to $7 billion by the end of fiscal year 2020.
Finally, while Nike may not seem like a tech company, it’s in fact adopting the latest in manufacturing technology in order to boost sales, earnings, and margins. For example, online sales allow customers to customize shoes, which sell at premiums compared to what is available in stores.
In addition, management is currently investing heavily in what it calls “ManRev,” or manufacturing revolution, which is expected to further boost the company’s core strengths.
CEO Mark Parker, who started out as a shoe designer, has been with the company for 30 years, and has been in the top job since 2006, points out that through the benefits of further production automation, and 3D printing, the company can reduce waste in product manufacturing, increase how quickly new products can hit the market, and offer customers even more customization.
In other words, via investing in state of the art manufacturing processes, the company can cut costs, maintain or win market share, and boost margins. In fact, Morningstar analyst R.J Hottovy thinks that Nike can boost its gross margins by as much as 310 basis points, or 3.1%, to 49% by 2020 using such techniques.
To put that in perspective, the last year’s margin decline that caused the stock to collapse by nearly a quarter was just 30 basis points. Which means that the market’s reaction to a successful implementation of even better economies of scale, and superior manufacturing methods should be much greater, resulting in potentially amazing capital gains.
Key Risks
There are several important risks to consider when evaluating Nike.
First and most obvious is the growing competition from upstarts such as Under Armour Inc (NYSE:UA) and Lululemon Athletica inc. (NASDAQ:LULU). That’s both due to strong execution on the part of these rivals, as well as the growing importance of sports apparel, which is more prone to fickle changes in fashion tastes.
A recent Bloomberg article noted that Nike generates more annual sales than Adidas, Lululemon, Under Armour, and Foot Locker combined, underscoring the increased challenge Nike has to defend its market share and generate healthy growth figures compared to its smaller rivals.
The article goes on to discuss that Nike might be having a harder time pushing through price increases on its shoes like it has been able to do in the past. This is due to more competition but also consumers “switching out of their running and basketball sneakers in favor of more casual styles, such as the Stan Smith and Old Skool lines of Adidas and Vans, respectively.”
The chart below shows the growth rate of Nike’s futures orders, which retailers place in advance of delivery. Futures orders are a decent indicator of future demand. Nike’s growth rate has slowed considerably in North America (green line) and China (blue line).
