Conclusion: We liked this Nike quarter about as much as we like week-old sushi. Yeah, the quarter definitely had some redeeming qualities, like a solid 13% futures growth rate, a beat on the gross margin line, and really encouraging signs out of Western Europe. But the reality is that the company put up a less than impressive 8% top line growth rate, and managed to translate that into a whopping 4% EPS growth rate. It missed our estimate, and we were hardly aggressive in our assumptions. Maybe we're being a little hard on Nike, as it has earned its spot as the dominant brand in this space, but the reality is that the company has put together such a fantastic string of results for so long (and has the multiple to match), and putting up a mere 4% growth rate is so….Adidas. If Nike wants to maintain its standing as one of the preeminent global companies and brands, its going to have to push the envelope a bit more going forward. We wouldn't be buying it here, and might go the other way if it bounces.
Here are some key standouts in the quarter:
- Underwhelming EPS: Truth be told, we were looking for EPS of $0.65. Gross margin was right in line with our model, but sales were low, and SG&A was high. Not what we want to see. Our numbers were not wildly out of NKE's guidance range.
- Futures came in strong -- +13% Globally. That's up about 2-3 points sequentially, though it's worth noting that the 2-year stack is down by about 2 points on both a reported and constant-currency basis. There were a lot of regional callouts. Emerging markets and Western Europe both posted futures rates that doubled sequentially. Unfortunately, Central Europe's trend was as bad as Western Europe was good. Japan is slightly less of a disaster, with futures down 10% vs -19% in 1Q (they're +1% ex FX -- unfortunately they can't exclude FX from results). China, unfortunately, is treading water in the low single digits. We have yet to see the rebound in China that Nike has been talking about for 12 months. US remains bullet-proof with 11% futures growth.
- ASP/Unit Less Balanced Than We Want: Of the 13% futures rate, 3% of it came from higher ASP, while 10% came from unit growth. The good news is that they're both positive. But we generally like to see a more balanced split between ASP and units. Higher ASP often has positive implications for margin.
- Nike has been in a trend where futures have been solid, inventories have been trending lower, and raw material/labor costs have been easing. Now that whole equation gets flipped to a certain extent. Futures are still solid, but inventories are growing faster than sales, and raw materials costs are going to turn from tailwind to headwind pretty much immediately. Nike is no stranger to finding ways to keep expectations low, but when Don Blair talks about input costs…he usually doesn't mess around.
- This Nike SIGMA chart is as bad as we've seen from Nike in years. Literally, it's so rare for NKE's SIGMA to trend down (bad inventory trend) and left (bad margin trend) at the same time. The only realistic way to get out of that position is to take it on the chin on the margin line to clear inventories, or vice versa. Nike will likely go the 'clear inventory by way of lower margins' route. Statistically speaking, stocks like it when inventory gets cleared as opposed to when margins hold tight in hopes of clearing inventory. Either way, Nike is in a less-than-enviable position.
- Let's just think about something for a minute…what happens when US futures revert to a longer-term trend-line rate of 5-6%? That's when we'll need the portfolio to really work -- most notably we'll need to see China pick up in a massive way -- and we mean the current lsd rate going up by a factor of 10x -- not just by a few points here or there. We're not making a call that the US is on its way out…but we are convinced that the current US futures rate is not sustainable. We need a China fix.
- Here's a nit pick, but NKE spent $402mm to repo 5.5mm in stock, and yet the share count barely came down. Let's not forget how big options are as a percent of compensation at Nike. They company needs to repo well over $1bn in stock each year just to keep the share count even.
I can already see it...a dozen people are going to ping me tomorrow and say "aren't you being a little tough on the company" (and I welcome those conversations by the way) My answer? "Yes, I am being tough." But a company as great as Nike needs to lead financially as much as it leads with product and in sports. It warrants greater scrutiny, not less -- because it can (and should) handle it.
