Conclusion: Nike is an astounding TAIL story that rarely gives you an opportunity to buy the dips. The impact of factory closures in Vietnam shouldn’t be as bad as the consensus thinks, but will definitely cost the company both lost volume and logistics expenses this year while it flexes around the sourcing cross currents. The company will almost certainly temper near-term gross margin expectations – though the consensus knows that. We still think it holds the line on the FY revenue guide, and we’re coming in ahead of the Street on the quarter, and the year. Valuation is rich, and the stock is under-shorted (only 1% of the float is short), so the stock’s ability to absorb bad news is likely tight. If the stock trades down on these near-term factors, we’re definitely buyers. None of the cross currents we’re seeing today has any affect on our TAIL earnings expectations, which are ~15% ahead of the consensus. Best Idea Long.
DETAILS
Nike hasn’t faced such a polarizing set of issues in a quarterly print in years. Between the supply chain issues facing the entire planet, the shutdown of Vietnam factories (~40% of Nike production), and the chatter and empirical evidence of local brands like Li Ning and Anta gaining share in China being translated to ‘Nike having a China problem’ – the volatility factor this quarter (Thursday night) is massive. Then take into account that the company’s 1Q (Aug) guidance was vague to say the least, and the range of outcomes relative to consensus is wide enough to drive a truck through.
But we think that the company’s results will come in ahead of consensus for the quarter, and the company will stick to its annual sales guidance of ‘better than $50bn’. Did we take down our revenue estimates given the supply chain shortage? Yes. By about $1.5bn for the year. Some of the lost production simply won’t be made up. But we’re still coming in at EPS of $4.67 for the year vs the Street at $4.22 – 11% ahead. For the quarter, we think Nike comes in at $1.28 vs consensus of $1.12, with the upside coming from a better top line and gross margins – despite higher air freight expenses. We should see higher margin DTC drive the business on top of a 70bp tailwind from FX, which should more than offset the higher logistics costs.
The stock is 10% off its recent highs (in a flat tape) as these concerns reared their ugly head(s). Along the way, we’ve heard some of the same datapoints from several investors about how far behind plan Nike is in manufacturing footwear – suggesting 10-15% of its planned footwear production is simply undeliverable as the plants are closed. It’s safe to say that this has become the consensus view. While there will definitely be some impact here, this isn’t Nike’s first rodeo. It has one of the most sophisticated global outsourcing networks in the world – in any industry. It has stepped up production at other plants in other countries, even if it needs to lean on China and pay higher tariffs. We think Nike is getting outside capacity and is squeezing out smaller brands, which will come up short with no recourse. It’s also prioritizing its most important customers – with Nike DTC leading the pack by a country mile (i.e. it has become its own largest customer by a factor of 4x) – and marginal distribution that sells lower margin shoes simply won’t get product. We also think that Nike is taking up price where it can, as NKE is one of the few footwear brands with pricing power. Lastly, on higher-end, higher-priced footwear, Nike dual-sources most of this product in different factory groups in different countries, specifically to get product to market when there is manufacturing risk at a certain country. The bottom line here is that any noise around lost business or excess costs are transitory. This is hardly a long-term risk, and is certainly not unique to Nike. Nike will outperform the rest of the supply chain as well as the competitive landscape in this context.
Then there’s China…We think this is blown out of proportion. Check out the five year stock charts for Li Ning and Anta – they’ve been absolute monsters. These brands are growing in the entry level and mid-price point zones – which are less important to Nike. We’re not discounting either of them as competitors – especially Li Ning. It’s the real deal. But it seems like people awoke to these local competitors just when the Chinese government made a push to consumers to buy local brands. People fail to recognize that they have been building momentum for years – at the same time Nike has been growing ~20% to build up an $8bn business in China, which we think is on track to scale to $15bn over a TAIL duration. When Nike faces strong local competition in any market, that’s when the product and marketing organization is at its best. Nine times out of ten, you don’t want to bet on Nike losing. We certainly won’t.
