Shares of Nike Inc. closed down nearly 7 percent on Friday after the company reported North America sales in the third quarter and fourth-quarter guidance that both missed Wall Street’s targets. But sales in the third quarter still more than doubled the growth rates of its closest rivals, Adidas and Under Armour, as Nike officials insisted its Consumer Direct Offense initiative is only getting started.
“The Consumer Direct Offense is connecting our powerful brand, to compelling innovation, to operational excellence, all in service of the consumer,” said Mark Parker, CEO, on a conference call with analysts. “And it’s a strategy that gives us a very clear path to sustain that momentum over the long-term.”
The earnings beat in the quarter in part reflected robust 11 percent currency-neutral growth in the quarter. In the fourth quarter, currency-neutral sales expanded 5 percent for Adidas and 3 percent for Under Armour.
The earnings improvement also reflected better-than-expected gross margin expansion, a lower effective tax rate and a lower average share count, which were slightly offset by higher SG&A expenses.
Highlights in the quarter included Nike Digital marking its first billion-dollar quarter with digital sales vaulting 34 percent on a currency-neutral basis globally. Other accomplishments included China’s 24 percent currency-neutral growth, strength across Nike Brand’s Power Franchises, continued recovery in Jordan Brand sales and inventories up only 1 percent despite the double-digit growth. Management talked up the many successes in Digital, particularly extending mobile connections to physical retail, and also discussed untapped opportunities in the moderate footwear channel, the apparel category and reaching women overall.
In many ways, Nike’s third-quarter couldn’t match the stellar performance seen in its fiscal second quarter. Growth in each region declined slightly sequentially on a currency-neutral basis although the growth rates were ahead of long-term targets provided at Nike’s Investor Day in October 2017.
Sales across regions on a currency-neutral basis in the quarter included:
- North America grew 7 percent year-over-year versus 9 percent growth in Q219. Consensus estimates had called for 8 percent growth;
- Greater China jumped 24 percent year-over-year versus 31 percent growth in Q219. Consensus estimates had called for 25 percent growth;
- EMEA advanced 12 percent year-over-year versus 14 percent growth in Q219. Consensus estimates had called for 11 percent growth;
- APLA (Asia Pacific & Latin America) advanced 14 percent year-over-year against 15 percent growth in Q219. Results were well above the consensus estimate calls for 6 percent growth.
For the current fourth quarter, Nike projected low single-digit percentage growth in sales, putting revenue below the $10.4 billion average of analysts’ estimates.
The softer guidance was largely due to a 6 percent hit from foreign exchange headwinds that was about two percentage points higher than the Street expected. Along with Higher-than-expected tax rate guidance, as well as continued high-single growth in SG&A, led analysts to reduce their estimates for the current fiscal year.
Analysts Still Bullish On Nike
Shares of Nike were down $5.82, or 6.6 percent, to $82.19. Shares had run up nicely this year – up from $74.14 at the close of 2018 – and were susceptible to some profit-taking. But analysts generally remained bullish on Nike’s prospects given the success of the Consumer Direct Offense effort has had driving innovation and has brought newness to the marketplace.
“In this environment, Nike is showing its stripes, standing as the clear outlier to the recurring revenue ceiling that dominates all brands,” wrote Nomura Instinet analyst Simeon Siegel Siegel in a note. He raised his price target on Nike shares to $91 from $85.
“Underlying momentum remains incredibly strong,” wrote Sam Poser at Susquehanna International Group, in a note. “Increasing digital prowess, a robust product pipeline, and exceptionally clean inventory will continue to drive healthy FX neutral revenue and margin growth across categories and geographies for the foreseeable future. Improvements in the speed of the product pipeline and digitally driven consumer engagement are still in their early stages and will provide a long runway for the top and bottom line growth.”
Poser maintained his $100 price target and “positive” rating.
“Despite the setback, we remain confident in fundamental momentum and long-term value creation opportunity. We continue to view NIKE as a solid core holding for large-cap growth investors,” stated Stifel’s Jim Duffy, who has a “Buy” rating at a $96 target.
In the quarter ended February 28:
- Revenue grew 7.0 percent to $9.6 billion.
- On a currency-neutral basis, sales were up 11 percent, topping consensus guidance for 10 percent growth.
- Gross margins expanded 130 basis points in Q3 as average gross selling prices expanded, strong demand drove higher full price sales, and higher margin Nike Direct growth outpaced wholesale growth. Margins were also favorably impacted by the shift of supply chain investments out of Q3 and into Q4. The margin improvement surpassed guidance by 60 basis points.
- Demand Creation (marketing) was flat in the quarter as sports marketing expenses declined based on the timing of investments.
- Operating overhead expense increased 17 percent to $2.2 billion driven primarily by wage-related expenses tied to investments supporting its Consumer Direct Offense initiative.
- The tax rate was 14.7 compared to 179.5 percent for the same period last year which included one-time charges related to the enactment of the U.S. tax reform.
- Net income was $1.1 billion, or 68 cents a share, exceeding Wall Street’s consensus estimate of 65 cents. The company showed a net loss of $921 million, or 57 cents, in the year-ago period due to the tax charges.
Revenues for the Nike Brand were $9.1 billion, up 12 percent on a currency-neutral basis and driven by growth across wholesale and Nike Direct, categories including Sportswear and Jordan, and continued double-digit growth across footwear and apparel. Reported sales for Nike Brand increased 7.7 percent.
By product category, footwear revenues for Nike Brand led the way, up 9.9 percent to $17.7 million and ahead 13 percent on a currency-neutral basis. Apparel sales were up 9.2 percent to $8.71 billion and added 12 percent currency-neutral. Equipment sales dipped 0.9 percent to $1.05 billion while adding 2 percent currency-neutral. Nike Brands’ EBIT (earnings before interest and taxes) reached $1.64 billion, up 17.3 percent.
Power Franchises Drive Growth In North America
By region, sales in North America for Nike Brand improved 6.9 percent to $11.7 billion and rose 7 percent on a currency-neutral basis. The region continued its recent bounceback after suffering three straight quarters of year-over-year declines in 2017 and 2018. EBIT in the latest quarter in the region expanded 9.6 percent to $2.88 billion.
Sportswear, Jordan, Nike Kids, and Running led growth across the geography. From a product perspective, the majority of the incremental growth was driven by Power Franchises ranging from the Air Force 1 and Air Jordan 1 to the Pegasus and Kyrie to the Max Air family of products including the new Air Max Dia for Women. The Jordan 11 Concord marked the biggest launch in Nike’s history, with the product selling out in hours.
Said Campion, “The strength of our product portfolio, and the fastest digital deliveries in our industry, fueled a very strong holiday season for Nike, outpacing broader retail growth by roughly 2X.”
Among product categories in the North America region, footwear led the way, up 10 percent on a currency-neutral basis and ahead 9.4 percent on a reported basis to $2.51 billion. Footwear improved sequentially on the 9 percent gain seen in the second quarter.
Apparel advanced 2 percent currency-neutral and 1.7 percent on a reported basis to $1.17 billion. That’s well down sequentially from the 2 percent increase seen in the second quarter. Campion attributed the decelerated growth to timing issues around the launch of NBA products and other items rather than any weakening in demand.
Added Campion, “In fact, consumer demand for our apparel in North America is very strong. Frankly, to some extent, it puts pressure on supply, but that is that’s a great point of pressure to have. We’ve got a really strong demand for our apparel in North America. So I wouldn’t overly index on the quarterly rate of growth.”
Equipment sales improved 2 percent on a currency-neutral basis and expanded to $128 million from $125 million overall. That marked a sequential recovery from a 3 percent drop in the second quarter.
Campion said the Nike Brand continues to have “strong brand momentum” in North America as noticed by strong responses to the Just Do It “Dream Crazier” campaign and executions around NBA All-Star Weekend.
He noted that “creating differentiated retail experiences” remains a priority in the region with consolidation at retail continuing. Part of that includes investments in Nike Digital, which grew 30 percent in Q3 in the region, faster than all other channels. At physical retail, Nike is infusing digital elements in newer direct concepts such as House of Innovation in New York and Nike Live in Los Angeles. Growth in New York and LA is over-indexing the broader market. Nike is also rolling out the Nike app at retail in owned stores and testing new services and concepts with strategic partners such as Foot Locker and Dick’s.
Said Campion, “We expect our strong pipeline of innovative product, the brand heat we have created, and an acceleration in the creation of new digitally-led consumer experiences to continue driving healthy growth in North America going forward.”
Nike Dominating In Targeted Cities In EMEA Region
In the EMEA region, revenues for Nike Brand rose 8.5 percent to $7.36 billion and increased 12 percent on a currency-neutral basis. EBIT rose 23.5 percent to $1.49 billion.
The gains were driven by double-digit growth in Sportswear and Jordan. Digital again paced the gains across channels with a strong double-digit pace. Campion said Nike is “far outpacing the broader market” in the EMEA region and the brand is seeing strength across geographies. Of the 12 “key cities” Nike projected in 2017 would drive 80 percent of the company’s growth through 2020, five are in the EMEA region – London, Paris, Berlin, Barcelona Milan – and Nike is rated favorite brand by consumers in all five cities.
As an example of its focus on those cities, he pointed to Paris, where Nike’s extensive women’s World Cup launch was held the prior week, the Jordan/PSG partnership was launched earlier this year, and preparations for the 2024 Olympics to be held in Paris are already underway. Said Campion, “It’s a great reminder that our 12 key cities were not chosen based on size alone but instead because we see these key cities as having the greatest potential impact on our brand and business.”
Digital Commerce Jumps 60 Percent in China
Greater China’s revenues for Nike Brand were up 23.0 percent in the third quarter to $4.51 billion and advanced 25 percent on a currency-neutral basis. EBIT grew 34.2 percent to $1.7 billion. The sales hike was led by Nike Direct, with digital commerce up over 60 percent.
Campion said China still represents the best example of Nike’s “outsized growth potential” internationally. He noted that while China is already the largest footwear and apparel market in the world, athletic footwear and apparel represents a smaller share of the total versus more developed markets such as the U.S. Champion said Nike’s commitment to tailoring product and messages to Chinese consumers’ preferences is helping the brand gain traction in China. Said Campion, “We have always believed that by being authentically connected to the Chinese consumer, we could help catalyze the rise of sport participation and sport culture in this market from sponsoring the Shanghai Marathon, to our partnerships with the China Super League, to working with the Ministry of Sport to expand physical education in schools. That is why, even amidst current geopolitical dynamics, Nike continues to deliver strong and sustainable growth in China.”
Japan And Korea Drive APLA Region
In the APLA region, revenues for Nike Brand grew 3.9 percent to $3.88 billion and added 14 percent currency-neutral. EBIT increased 15.8 percent to $983 million.
The revenue gains were fueled by balanced double-digit growth across footwear and apparel. Japan and Korea drove the growth with momentum seen in their key cities, Tokyo and Seoul respectively. Nike Digital expanded over 60 percent due to further investments and the leveraging of digital partnerships.
Said Campion, “As we look ahead to the Tokyo 2020 Olympics, we could not be more thrilled with the momentum we are building in Japan. Both the SNKRs app and newly launched Nike app are resonating strongly with consumers. Our Running innovation has also resonated with the highly discerning Japanese running consumer, with Nike having ascended to #1 in Running across Japan.”
Revenues for Converse were $463 million in the quarter, down 4.3 percent on a reported basis and off 2 percent on a currency-neutral basis. Double-digit growth in Asia and digital more than offset declines in the U.S. and Europe. EBIT for Converse improved 14.5 percent to $79 million.
As of February 28, Inventories were up only 1 percent, reflecting “a continued healthy pull market for Nike globally and stronger supply and demand management,” said Campion.
Consumer Direct Offense Paying Dividends
Campion talked up the broader benefits of Nike’s “editing to amplify” approach as part of its Consumer Direct Offense that has reduced the total number of styles to hone in on top-sellers. He said, “In any given season, our Power Franchises include select icons within Sportswear such as the Air Force 1 and Air Jordan 1, performance franchises such as the Pegasus, as well as new innovation platforms such as the VaporMax, Air Max 270 and React. The new dimension we are bringing ranges from collaborations with athletes and influencers, to compelling new elements of design, to infusing new innovation into longstanding performance franchises.”
Increased innovation, another key pillar of the Consumer Direct Offense, is driving the “vast majority” of Nike’s incremental growth. In Q3, Nike launched the Air Max 720 to strong demand as well as the Adapt BB, Nike’s auto-lacing Adapt technology. He added that Nike is “scaling innovation faster than ever before, with React and our new Max Air platforms being leveraged across multiple performance categories and in Sportswear within just the first year of launch.”
Updating key styles with new materials, prints and colors, on significantly shorter timelines have also been a key to keeping Nike Brand’s mix fresh. The related Express Lane program “drove well over 10 percent” of revenue in the quarter.
On digital, Parker discussed “supercharging Nike+ membership for even greater personalization with consumers. When we offer more tailored product and experiences, we bring more value to the consumer and it opens up more opportunities to grow our business.”A new, advanced algorithm in its apps, for instance, provides rewards foremost active members. Parker said consumers using the Nike app at retail spend 40 percent more on average than those who don’t. The SNKRS app also remains popular as traffic and revenue in the quarter were up triple digits. Seventeen of the top 20 SNKRS launches had 100 percent sell-through and the record-breaking Air Jordan 11 Concord launch averaged300 transactions per second.
Growth Opportunities In Women’s, Apparel and Moderate Channel
Parker also talked up several untapped opportunities, including expanding the Nike brand further into the moderate channel, which includes Kohl’s as well as the family shoe chains. Said Parker, “We’ve fast-tracked new collections under the $100 price point and we’re aligning the merchandising and marketing teams to support them throughout the marketplace.”
He again talked about apparel as an “outsized growth opportunity.” Plans in the category include a sharper focus on key classifications in Nike apparel and accelerating growth by offering fresh options in top-sellers “much like we do in footwear with our Power Franchises.”
Outside apparel, Nike this year will be launching another new cushioning system, introducing more than 40 new styles of bras in an expansion of inclusive sizing, and expanding its auto-lacing Adapt technology to new categories.
Parker said Nike’s women opportunity “experienced an important inflection point” last week in Paris where Nike unveiled kits for the 14 of the 24 teams participating in the event. The women’s push saw a particular benefit from the “Dream Crazier” campaign narrated by Serena Williams that broke several of Nike’s consumer engagement records across all four geographies. In North America, the execution became Nike’s most-shared Instagram post ever and one of the most-successful Nike tweets of all-time.
In terms of product, Nike has aligned merchandising teams for one unified women’s vision at retail in collaboration with R&D. Parker said, “A more complete offense is taking shape and it’s incredibly energizing.”
High-Single-Digit, Currency-Neutral Growth Seen For Q4
Regarding its outlook, Nike expects growth in the high-single-digit range in the fourth quarter on a currency-neutral basis. With the impact of 6 points of FX headwinds, low-single digit growth on a reported basis is expected.
Campion noted that the growth will build on strong gains in the year-ago fourth quarter when sales grew 8 percent currency-neutral and 13 percent on a reported basis. The year-ago growth benefited from the strong launches of the React and the Air Max 270 along with the men’s World Cup. Added Campion, “So, our outlook for strong currency neutral revenue growth this Q4 is a testament to the sustainability of the growth that we are delivering through the continued execution of our new Offense.”
Gross Margin in Q4 is expected to expand roughly 75 basis points, ending the year exceeding its long-term targets. Strong continued strong full price sell-through and strong growth through Nike Direct businesses are expected to offset higher input costs, specifically cotton, chemicals, and labor, FX sourcing headwinds, and the shift of supply chain investments from Q3 into Q4.
Campion noted that the disparity between currency neutral and reported revenue growth is expected to peak in Q4 before narrowing significantly in FY20 based on current FX rates.
SG&A is expected to expand in the high-single-digit range in Q4 due to continued growth investments. The tax rate in Q4 is expected to be between 18 to 20 percent, slightly higher than expected due to uncertainties stemming from the ongoing finalization of regulations related to U.S. tax reform.
Nike also provided an upbeat initial outlook into fiscal 2020 based on “our current momentum, our brand heat with consumers, our robust innovation pipeline, and the positive early signals we are receiving from our Nike Direct business and our strategic wholesale partners.”
Nike projected high-single-digit revenue growth as well as gross margin expansion and profitability in line with projections provided at its 2017 Investor Day.
“We are thrilled with our current momentum,” concluded Campion. “That said, we are still in the early stages of executing the Consumer Direct Offense, with much more opportunity ahead of us. So, we will continue to focus our investments on the digital transformation of Nike and in the areas of our business where we see the greatest potential to grow and create value for both consumers and shareholders.”
Image courtesy Nike