Massive Redemption Quarter For Nike

09/23/20 09:40AM EDT

Below is a complimentary research note (NKE | #Redemption) published on 9/22/20 from our Retail analysts Brian McGough and Jeremy McLeanWe are pleased to announce our new Sector Pro Product Retail Pro. Click HERE to learn more.

Massive Redemption Quarter For Nike - 9 23 2020 9 37 34 AM

We expected this to be a redeeming quarter for Nike after reporting a stinker 13 weeks ago – and the company more than delivered on our bullish expectations.

Revenue came in flat for the quarter, which is simply a herculean effort/result on the part of the company given the disruption that covid is having on global consumer shopping patterns. We were 300bps ahead of consensus modeling a -13% revenue decline.

Nike massively outperformed there – in nearly every region of the globe except APLA (non-China Asia Pac and Latin America). Not a shocker that digital growth led the way -- as e-comm (which is 1,000bp GM accretive vs selling wholesale) was up 83% for the quarter. EPS came in at $0.95 – smoking our high on the Street estimate of $0.55. While Gross margins also came in well ahead of our model – declining by only 94bps vs last year (vs being down 822bps in the May quarter) – it was really SG&A that made up for a big portion of the margin beat. Demand Creation (marketing) was down by 34%, which boosted EPS by $0.18 per share.

Inclusive of a 50bp reversal of a COGS accrual (which helped by $0.03 per share) I’d peg a cleaner number at $0.74 per share vs the reported $0.95 – still more than solid relative to expectations. To be clear, I don’t like when Nike leverages Demand Creation. This company operates at peak performance when it is spending money to elevate the brand.  

It is a tremendous steward of capital on both the P&L and the balance sheet, and when marketing dollars go out the door there is invariably a follow through on the top line in future quarters. A big culprit for the decline in Demand Creation dollars was the absence of the Olympics, as well as most professional sports being shut down for most of the quarter. We’re modeling a sharp rebound in Demand Creation expense starting in the current quarter, which should facilitate a sharp acceleration in the top line over a TREND duration.

The only other real bone to pick is on the balance sheet, where the cash conversion cycle was mixed. DSOs were solid coming in 7 days below last year, suggesting that Nike is hardly chasing wholesale revenue.

Quite the opposite, it’s walking away from marginal distribution, which shows in the numbers. Inventories were up by 13 days vs last year – that’s big/bad at face value though we should note that this is a huge improvement from the 77 day increase we saw last quarter at the height of the covid shutdown.

Nonetheless, we should model an increase in closeout sales in the upcoming quarter as Nike clears out excess product. The decline in payables raised an eyebrow for me – 12 days below last year, which is the worst performance we've seen in over 18 years. This is the kind of environment where Nike should be leaning on suppliers, but the numbers suggest that the opposite happened. It almost appears that Nike is throwing its suppliers a bone and paying faster – which just ain’t Nike’s style.

All in, not the end of the world and hardly a thesis-buster. Just something where we need to get a good answer from the company as to what’s going on with its cash conversion.

As it relates to the stock, we still like this as a Best Idea Long. Will it make you rich buying it at this valuation? Not really. But over a TREND duration we’ve got every line of the P&L inflecting positively over a 1-2 quarter basis.

Then due to the way Nike is changing up its model to go Direct to Consumer during a ridiculously tough environment (i.e. its ripping off the band aid when its at a cyclical low), we’ve got it clocking in at a recovery margin profile of 16% -- which is something Nike hasn’t seen in over 20-years. Pre-pandemic margins were ~12%).

Most companies in Consumer Discretionary will be looking at recovery earnings well below last year’s peak – but Nike is one of the few that should meaningfully buck that trend and push Return on Net Operating Assets close to 50% post-pandemic – which is a stunning benchmark for a company of Nike’s size. Nike’s earnings CAGR should be 35% over the next 3-years leading up to May23 EPS of $4.00+.

Even if we assume multiple compression as numbers normalize, we’ve got upside to $140/$150 over 12 months – which is more than we can say for most companies in Global Retail.   

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