No changes to our view. We love the unrealized earnings power here and are putting our model where our mouth is. But it’s important to be mindful of duration.
The quarter was outstanding. We thought they’d beat the consensus by better than a dime. The headline print was $0.03 better however the tax rate was higher than expected, which muted EPS by about $0.06. We can’t really call that ‘non-recurring’ because the fact of the matter is that with the US business en fuego, Nike is earning a greater proportion of its profits in higher tax jurisdictions. But operationally, Nike crushed it.
Relative to our expectations, revenue and SG&A both came in better, while Gross Margins missed. The latter came as an initial shock to us. Clearly, input costs are still an issue, and the company has too much apparel inventory in China and Europe. On the flip side we saw futures ACCELERATE on every basis you want to analyze…1 yr, 2 yr, C$, R$. Of note is the North America futures number – which was +22%. Now…let’s put this into perspective. This is an $8bn business. If we assume that 85% of this business is on the futures program, then we’re talking about $1.5bn in annual revenue. That's like adding an UnderArmour, a New Balance, an Asics, a Skechers and a couple of Crocs.
By our math, the NFL deal, which flips from adibok to Nike in early April, will probably be around $200-$300mm in year 1. That’s the lower end of where Reebok had it. That’s also why we think Nike will double this rate in year 2. And likely grow it by 50% in year 3. If this is the case in year 1, then let’s say $200mm of it is set for delivery within Nike’s current futures window. Assuming that 85% of Nike’s US business is on the futures program, that suggests that the NFL deal helped futures by about 5%. So…22% minus 5% = 17% growth in North American futures. For what it’s worth, we have to look back to the Clinton Administration to find the last time the North American business grew at this pace – and back then the company was stuffing the channel with apparel product and was STILL half the size it is today.
Obviously, we did not like the Gross Margin pressure. It’s uncharacteristic for Nike to miss on the Gross Margin line given that it has such great visibility into its supply and demand as far as six months out. Could it be that the inventory clip on margins is just hitting them harder than they’re admitting? Or could it be that the cost environment is simply not deflating like the entire world in global retail seems to think? Maybe it’s a little of both. But if any of it has to do with lack of realized cost deflation, then there’s going to a big wake up call for others in the industry that don’t have the same kind of control over their supply chain (which is somewhere between 98-99% of retail).
We’re tweaking our estimates – and we mean tweaking. We’re still looking for earnings in 2014 starting with an $8. The Street is at $6.75.
Here's a link to Monday's preview headed into the quarter - "NKE: 3 Peat".
Brian P. McGough
Managing Director