Nike is taking off today in a weak tape on heavy volume. What gives? I think the quarter next week will come in just fine. In fact, my model is nearly 10% ahead of consensus for the quarter. But I’m not so sure that will matter this time. Think of the following…
1) This is a global growth story in a slowing global and increasingly stagflationary economy.
2) With 50% of sales outside of the US, the dollar has been a meaningful driver to sales and gross profit. Nike is one of the few companies that has actually taken excess FX-related cash and reinvested back into the model instead of printing as higher EBIT margins. This allows NKE to sustain growth due to better infrastructure, and leaves it cost levers to pull in case things slow down. Good stuff. In addition, it is one of the few names anywhere near this space that has been through several FX cycles. Its hedging strategy is all about profit preservation. But what does all this mean? In ’09 the company’s P&L is going to shift from a rapid-top-line/improving gross margin story, to being a slower growth SG&A leverage story with FX offset shifted to gains in ‘other income.’ Quality of earnings probably won’t improve for FY09.
3) Costs are not getting better in Asia. 97% of the industry’s footwear is made in China (bad). Nike is less exposed at about a third, but it also is far overexposed to Vietnam (also a third of its footwear production). Two weeks ago, Hanoi announced 28% inflation – its highest rate in 16 years. In Vietnam and Thailand we’ve seen factory workers strike because mid-teens wage increases are not enough to keep pace with inflation. Ultimate, this has to impact Nike. They’re big and smart enough to pass it through to the rest of the global supply chain, but that process is lumpy.
4) Did you see Belle International? Belle is the largest shoe retailer in China. It has the exclusive distribution rights to many brands, and is also a major partner for Nike and Adidas. The stock went from 8 to 6 in a week. Margins compressed just as the Olympics peaked and all partner brands filled potential capacity as much as possible to build awareness in advance of the Olympics. Now we see China’s retail sales at a whopping 23%, but with the growth incrementally coming from Beijing, and with the Real rate ex-inflation slowing. The China growth opportunity remains HUGE. But it should take a breather for a few quarters.
5) We’re still only 3.5 months into Nike’s fiscal year – this is a time when the company is NEVER upbeat with guidance – even when not faced with these macro challenges. Guidance won’t be good. They’ll try to buy themselves breathing room.
6) ROE/ROIC has started to decouple. Cash is building faster than the company can invest it at prevailing rates of return. Not a bad problem at all in this environment. In fact, that may one of the primary reason why this name is viewed as safe by many PMs. Yes we’ll see stock repo. Yes we’ll see dividends – but both growing at a steady measured pace. Don’t expect any sudden capital returning events. Acquisitions are likely – especially with Umbro now tucked in. Timberland makes sense. I could even justify a retailer.
To those that know me, you know that I fundamentally believe in Nike’s strategy – which is why in a former life my family and I packed our bags, gave up Wall Street, and moved out to Oregon so I could work there. But based on what I see happening on the global stage, I’m surprised to see the stock continuing to grind higher.