HUGE Ecosystem Read. The irony with this Nike print is that in the 2.5 years since John Donahoe became CEO the company scaled back approximately 20% of its wholesale distribution, and now it reports a quarter where it is sitting on WAY too much product -- +65% inventory growth in the US and +44% globally. It can talk all it wants about shipment timing, but the reality is that fall product is hitting the floor the same time as holiday – which is a big problem. Now it’s going on absolute offense to clear the excess product, in large part through wholesale channels who ‘made the cut’ in not being cutoff by Nike. The bottom line is that Nike has ‘too much stuff’, and there are severe consequences for Nike’s ecosystem – both retail partners and competitors. Think about it, inventory is up $3 BILLION globally, with $1.5-$2bn of that in the US. The company guided down gross margins big to clear the product – about $1.2bn in markdowns or $700mm in the US over the next three quarters. No athletic retailer or brand is safe right now – because Nike is going to make their financial algorithms absolute hell. We’re short Adidas, ONON, DKS, FL, HIBB, and BGFV – all of which should be hurt by this. But it’s also a really bad look for UAA and even the vaunted LULU – given that more than half of the excess inventory is in apparel. This is also a statement about softgoods retail overall, especially apparel, which we have been short all year for this very reason. Management teams are underestimating the competitive response of how brands and retailers will react when ‘stuck with too much stuff.’ Interestingly enough, Nike noted that it has not seen a consumer slowdown yet, but is preparing for one. Smart. That’s why it’s guiding down 2Q (Nov) margins by 400bp. This is as big as that day last month when WMT and TGT guided down nearly simultaneously due to excess inventory. The repercussions were far reaching. We’d be short nearly every name in the space (with the exception of DECK – if that trades down we’d be buying) on this news out of Nike. This is big time. If you didn’t know that we are in an earnings recession, well now you know.
As For The Quarter, it was sloppy. Reported EPS of $0.93 vs the Street at $0.92, but adjusting for a more normalized tax rate earnings were closer to a buck – which was in line with our model. Revenue beat, but gross margins were downright anemic. Came in down 220bp vs the guide of down ~100bp. Demand creation expense was on the light side, which we never like to see out of Nike as it fuels demand, but that should accelerate meaningfully in the coming quarters. At face value the company’s revenue guide looks flat-out bullish -- +~20% in constant currency in 2Q. We’ve got North America revenue +25% in 2Q, which is massive given the sheer size of the revenue base. But think about it…it’s going to clear $3bn in inventory lightning fast – so we should see an elevated top line and weak margins for the next two quarters. We’re coming in at $3.30 for the year, $4.25 in FY24, and then $6.50 three years out. We still have to see where numbers shake out, but we suspect we’ll be 10% ahead of the Street this year, and 15-20% ahead in the outer years.
What To Do With The Stock. First off…let it breathe. See where it trades (-10% after hours to about $86 – no multiple erosion, just earnings compression) and where the consensus shakes out in the coming days. The immediate move is to short everything else. From a timing perspective, Nike should be emerging from its inventory problem in Spring of 2023, which is the same time that we think retailers will be guiding down MATERIALLY (like, by 40-50%). So on a relative basis, Nike looks pretty good from here. We’re a broken record on this, but as it relates to retail overall, we think that 3Q estimates are probably ok…probably. 4Q however, is a problem. Holiday is going to be a dogfight, inventories across all of retail in almost all categories are too high, we’re in a rising rate environment that the consumer is levering up into, consumer confidence is in the tank, and the personal savings rate is at cycle lows. Will the consumer show up for holiday? Yes. But will be buying at steep discounts. Numbers will come down again. But then we get into 1Q where we hit HUGE multi-year growth comps, and the consumer will be tapped out from 4Q spending. That’s when we think management teams will have ‘had it’ after getting kicked in the teeth for 2-3 quarters and nickel and diming guidance. That’s where the REAL guide-downs enter the equation (and the bankruptcy cycle starts up again). By Spring, we should have stocks that are trading at trough multiples on newly trough (and doable) earnings expectations. Nike just took its lumps 6-9 months early, as it actually has a macro process and a disciplined way of aggressively dealing with an inventory problem instead of having it persist for way too long. There’s still multiple risk with Nike over the near-term, as it’s trading at 25x earnings. No reason why it can’t drift lower – at least directionally – with the group as retail continues to implode for the next six months. But on a relative basis, we think Nike should outperform in both earnings and revisions while the carnage unfolds in retail more broadly. If you have to own something in Retail, we’d own Nike on this sell-off. If you can wait six months for the inventory to clear, and for us to get a line of sight to getting out of Macro Quad 4, then we’d wait to buy more aggressively. If you have duration, we think you’re looking at EPS of $8 over 4-5 years, which is probably worth 25x earnings. That’s a $200 stock vs $86 today. Are there other/better names out there that are 3-5-baggers in that time frame? Yes, there will be plenty – but not until we get earnings guidance in Spring ’23.
