Nike (almost) always gives both the bulls and the bears something to chew on. But as a whole, this was a FAR better quarter than the consensus expected, and for the most part, in line or better than we expected. The Company came in at $0.85 vs the Street at $0.61, and our estimate of $0.80. The upside was driven by simply ridiculous top line growth – clocking at a 20-year high (ex pandemic snap back quarter) revenue growth rate. Gross margins also came in 100bp better (though still down 300bp yy due to inventory clearance). Ultimately, despite the blowing out of the aged inventory left over from last quarter, Gross Profit was still up 10% for the quarter – an impressive feat.
China showed dramatic sequential improvement, which we also expected (and got tons of pushback on), coming in at +6% in constant currency – its best performance in six quarters. Per the company (we can’t verify this) it extended its lead as the #1 brand in China. To its credit, footwear sales in China were up 21% in the quarter – yes, off an easy -26% comp last year. But the directional move is outright bullish. On top of that, Footwear was up a staggering 39% in the US, and 37% in EMEA. The company’s footwear game is on fire right now, which is core to our thesis. It’s tiering and distributing exclusives better than we’ve ever seen from this company, making in-season styles nearly impossible to discount – particularly in Air Force 1s, Jordans, Nike SB, and Dunks.
The elephant in the room is that inventories are still materially elevated vs last year – $2.8bn higher to be exact. The part of the quarter we got wrong is that we expected an extra $1bn in inventories to be worked through. Management noted that off price sales and closeouts are down – though our sense is that it was referring to Footwear. The Footwear business looks EXTREMELY healthy to us. Apparel, however, is still a problem, and our sense is that we’re going to see Nike more aggressively stuff its wholesalers – especially the likes of Hibbett, Kohl’s, JD (the old Finish Line) and Foot Locker with apparel inventory that they simply don’t want. But if they want the footwear styles that are driving traffic, they’re gonna take it, clear it, and eat the margin. That’s life when you retail Nike product. What Nike won’t do this time around is use China as a dumping ground for excess apparel. It’d be better off burning it to protect the brand and keeping regained China momentum on the rails. Mind you, this is a major China re-opening play, as 40% of EBIT used to come from China, and now that’s down closer to 30%. Going forward, a more normalized rate should settle in somewhere in the mid-upper 30s, given the permanent capital influx Nike injected into China to re-ignite the brand. Digital strength was robust in the quarter, up better than 30% vs last year – again, core to our thesis.
No material changes to guidance. Management tried to keep consensus for the year relatively unchanged, but as we expected, numbers are headed higher, and we think that next quarter they’ll head higher still. This stock isn’t cheap at 30x earnings, but it’s part of the 10% of names in Retail that are unlikely to see downward revisions next year. Expensive, but warranted. We think that Nike will emerge into a ‘safety stock’ in 2023, the same way you see names like HD and ULTA today – both of which we’re short. Over a TAIL duration, we still think the play here is that Nike pushes 18-19% margins vs ~12% today, which gets you to ~$7 in EPS power over 3-4 years – roughly double what Nike is earning today. Can we justify a 30x multiple in perpetuity? Probably not. But we see earnings revisions heading higher over a TREND and TAIL duration, as Nike is at the end of an earnings bottoming process (it has had flat earnings since the start of the pandemic).
With so few high quality names with impenetrable balance sheets that are facing upward earnings revisions here, we think this name is tough not to own at a time when our short list (currently with 60 names on it) has never been longer.
