Nike (NYSE: NKE) is a leading athletic footwear and apparel brand with over $45 billion in revenue. Despite ongoing pandemic and supply chain challenges, the company is making a steady comeback and is expected to continue to benefit from increased consumer awareness of health and fitness. In this article, I will discuss the latest trading updates and my opinion on the stock.
Nike ended fiscal 3Q22 (ending Feb 2022) with revenue up 5% YoY (8% CC) driven by 17% growth in Nike Direct. Wholesale trade returned to growth with sales up 1%. Nike digital grew 22% due to strong demand through the Nike app. Finally, sales at Nike-owned stores increased 14% with much better traffic in the quarter. Regarding the latest Russia-Ukraine, turnover in the two countries represents less than 1% of the company’s total turnover.
As the brand continues to move towards a direct-to-consumer (DTC) model and comprehensive pricing strategy, gross margin saw a 1% increase from 45.6% in 3Q21 to 46.6 % in 3Q22. Additionally, management noted that over the past 4 years the number of wholesale accounts has been reduced by more than 50% as Nike continues to invest in its own channels. This is evident in the latest earnings call from Foot Locker (FL), where management highlighted that Nike products will represent 60% of total inventory (compared to 70% in 2021 and 75% in 2020) in 2022.
Operating margin of 15% was down slightly from 16.2% last year, driven by normalized demand generation spend (8% of revenue in 3Q22 vs. 7% in 3Q21) and expenses general and administrative (32% of revenue in 3Q22 versus 29% in 3Q21) . Due to a higher effective tax rate (16.4% vs. 11.4% last year), net margin was 12.8% vs. 14% in 3Q21, which explains why EPS fell slightly from $0.9 to $0.87.
During the 2Q22 call, Nike mentioned that supply disruptions in Vietnam due to Covid caused the company to cancel production of 130 million units, but weekly production of shoes and clothing had returned to 80% of pre-closure volumes. Since fiscal 3Q22, all factories in Vietnam are operational with production back in line with pre-closure volumes.
While production has returned to normal, transit time remains an issue. According to management, transit time is now 6 weeks longer than pre-pandemic levels and 2 weeks longer than in 3Q21, as port congestion has not improved. Although Nike was able to handle the impact of 4 weeks better than industry averages, inventory in transit still represents approximately 65% of total inventory.
Representing approximately 18% of total Nike brand revenue over the last 4 quarters, Greater China saw year-over-year revenue declines of -5% and -20% in 3T22 and 2T22. Although the region still generated over $2 billion in CNY-driven revenue in 3Q22, Nike noted a 5% drop in revenue at Nike-owned stores and a 19% drop in digital due to ongoing supply delays.
Along with supply chain issues, current challenges around Omicron remain an issue as Chinese governments take a holistic approach to containing the virus. This not only impacts Nike’s business, as owned stores and retailers are forced to suspend operations, but also poses challenges from a logistical perspective, as inter-provincial and inter-city transportation has been significantly limited. Subsequently, e-commerce sales have slowed as goods cannot be delivered on time.
Also, China seems to be a much more competitive market for western brands. For example, 2021 results from adidas (OTCQX:ADDYY) show that sales in China (~21% of total revenue) grew only 6% YoY, which is significantly slower than in North America and EMEA, at 13% and 23%, respectively. During the 4Q21 earnings call, the CEO acknowledged the following:
So in terms of the situation in China or the Chinese market, there’s — the indications that we’ve given, we think the growth is likely to be more or less in line with western competitors in the market. We still believe that local Chinese competitors will grow at a higher rate than that.
Digging deeper, we can see that domestic Chinese brands such as ANTA and Li Ning have actually outperformed their Western counterparts over the past 3 years. As a result, some of Nike’s slowing revenue growth in China could be attributed to competition and potentially issues with Xinjian Cotton, which has seen a number of Chinese celebrities cut ties with the brand. The thought leadership remains optimistic about the Chinese market, something to watch for in the future.
Nike’s investments in digital have paid off relatively well. In fiscal 3Q22, digital revenue grew 22% (CC) and the Nike mobile app grew more than 50% to overtake nike.com. For the quarter, Nike digital grew 3% year over year to account for 26% of total Nike brand revenue.
Given valuable digital assets such as the Nike mobile app, SNKRS app, NTC (Nike Training Center) and NRC (Nike Run Club), Nike has a number of marketing levers to pull. . For example, Nike has partnered with EA Sports to give members who run 5 miles in the Nike Run Club the chance to unlock in-game Madden NFL rewards.
Besides owned digital channels, Nike is actively involved in the metaverse, with Nikeland on Roblox being a primary platform where a total of 6.7 million players from 224 countries have visited the virtual space since its launch. Additionally, Nike also acquired RTFKT Studios to launch the first Nike-branded NFT in Q3.
For fiscal year 2022 (May 2022), Nike expects revenue to grow in the mid-figures, from $44.5 billion in fiscal year 21 (+19% year-over-year) to approximately $46.8 billion. This represents a growth rate of almost 20% compared to FY19 and a 3-year CAGR of 6%. As supply chain issues ease going forward, management believes that fiscal 2023 should be another year of strong growth.
Nike rose from a low of $60 in March 2020 to an all-time high of $178 in November 2021, driven by (1) a stronger public desire to stay healthy under Covid-19, (2) a trend towards ‘athleisure which benefited from WFH, and (3) prospects for reopening in major markets which have recovered faster than expected. After seeing a sharp sell-off of more than 30%, the stock rebounded 18% from lows of $118 in mid-March when the Russia-Ukraine crisis hit the headlines.
From a valuation perspective, Nike is currently trading at a forward P/E of around 30x, a premium to its peers, but rightly so. Although Greater China is a slower market, Nike remains a dominant player with an attractive brand in the global sportswear and sports footwear market. As the company continues to grow its DTC business by cutting out middlemen for higher gross margin and gradually recovers from the impact of Covid and supply chain challenges, I believe the current valuation represents a fair price for a wonderful company.