NKE | Took Down Expectations Too Much

As expected, Nike threw the investment community a curve this quarter. Though it beat the quarter marginally ($1.16ps vs Street at $1.12) the real news is that it lowered top line expectations for the year from low double-digit to mid-single-digit, representing about $2-$3bn in lost revenue due to supply chain issues. The good news is that the demand side of the equation appears to be solid, with digital penetration (21%) and full price selling (65%) hitting record high levels. Definitely not an ideal scenario, but far better than the inverse – too much supply and not enough demand. In fact, Gross Margin was up an impressive 170bp this quarter, and will still be up at least 100bp next quarter despite materially higher logistics costs (air freight, ocean surcharges, factory switching costs). That speaks to the power of the shift to a DTC model, which is driving both growth and profitability. There’s going to be a wicked snapback in the model next year as supply catches up to demand on a global scale – so while we’re taking down our FY22 (May) EPS to $3.93 -- +10% yy – we’re leaving our outer year estimates intact. For May 23, we should see a massive acceleration in the top line to over $55bn (+15%) – and with the absence of the excess supply chain costs we should see that growth leverage to a 250-300bp EBIT margin increase, and a 35-40% boost in EPS. Our sense is that the consensus is going to come in for the year closer to $4.50 in EPS, while we’re at $5.30 – then building to $7.50-$8.00 over a TAIL duration. Let’s also not completely discount the potential for Nike to come close to $50bn in revenue THIS year – which would not surprise us even though the company just completely reset the earnings bar. The way we look at it, the company is firing on all cylinders as it relates to building consumer connectivity with the brand(s), and it simply needs the inventory to fill the void. Some inventory is stuck on the water (i.e. still sellable), while other product is lost forever (factory shut downs). If factories open sooner than later (as some are), the top line is headed above the company’s near-term guide. Based on after-hours trading, we’re not getting the massive sell-off that we were hoping for to load up, but the reality is that the company should see material earnings upside in year 2+, with a call option on nearing $50bn in revs this year. If our TAIL estimates are right, we think you’ve got 30x-35x $8 in EPS, or $260. Discount that back by 10% annually and it suggests $190 over 12 months. While we prefer Adidas over Nike at current levels, we’re buyers of Nike here. Best Idea Long.