Nike Earnings Preview: China Holds The Key For Long Term Growth

Sports giant Nike (NYSE:NKE) is scheduled to report its Q4 2013 results on June 27, 2013. The company’s results in the previous quarter were encouraging on account of 9% y-o-y growth in top line and expansion in gross margin. We expect revenue growth in the mid-single digits in Q4 2013, on account of tougher y-o-y comparisons as revenue in Q4 2012 was driven by Euro Champs, Olympics and NFL Launch. The gross margin should also expand in Q4.

We expect Nike to record strong sales growth in North America, Central & Eastern Europe and emerging markets. Nike’s strategy to focus on discrete product categories (known as the category offense) will continue to fuel its future growth. Nike’s Chinese sales have been impacted in the past few quarters due to excess inventory in the region. It will be interesting to see Nike’s results in Greater China this quarter as the reported futures orders were positive from this region in March 2013. The sales growth in Western Europe will be impacted by difficult y-o-y comparison in Q4.

See our complete analysis for Nike

Recap of Nike’s Q3 2013 Results

In Q3 2013, Nike’s revenue grew by 9% annually on the back of broad based growth across several geographies and product categories. Its gross margin expanded by 30 basis points annually owing to higher prices and reduced raw material costs, which were partially offset by increased labor wages, higher discounts, currency headwinds and other factors.

Nike brand’s direct-to-consumer sales rose by 22% annually driven by a 12% increase in comparable store sales and a 33% increase in e-commerce sales. Nike brand footwear and apparel sales, which together account for around 80% of the valuation of the company grew by 9% and 7% annually respectively. Global futures orders grew by 6% in dollar terms and 7% in constant currency terms.

Category Offense Is Fueling Growth For Nike

Nike is focusing on individual product categories such as running, football, basketball, men’s training, etc. to drive innovation and incremental sales in these product categories.

Running and basketball are two categories for Nike that are seeing high growth and have strong market potential. The company is tapping growth in these categories by providing innovative technologies such as Nike Free, Lunar, Flyknit, Dri-Fit, etc. and leveraging partnerships with leading athletes, such as Kobe Bryant, LeBron James, etc. We expect these two categories to continue to grow at a strong rate in the future.

Strong Growth Is Expected In North America, Emerging Markets and Central & Eastern Europe

North America represents the biggest market for Nike accounting for around 42% of its revenues. The company continues to maintain a strong growth momentum in this market on account of factors such as continued innovation and superior marketing. Nike brand revenues in North America rose by 18% annually in Q3 2013, and we expect the company to achieve a similar performance in Q4 2013.

Emerging markets’ revenue rose by 8% in constant currency terms in Q3 2013. The reported futures orders from this geography in March 2013 were 16% higher (excluding currency impact) than the prior year. Hence, we expect high growth from this region in Q4 2013. Emerging markets provide long term growth opportunity for Nike and the company will leverage international sporting events such as FIFA World Cup and Olympics in Brazil to drive its future sales.

With growing economic prosperity in the region, Central & Eastern Europe represents another fast growing market for Nike. The company saw 16% y-o-y growth in this region in Q3 2013. Reported futures orders were up by 11% from this region in March 2013, and we expect high demand from this market to continue in the future.

Recovery Underway In China

China is expected to hold the key for Nike’s future growth owing to its large population and fast growing economy. However, Nike’s Chinese sales have been hit in the recent past due to excess inventory and macro headwinds. The company is actively addressing this situation by clearing its excess inventory and altering its product portfolio to suit Chinese tastes and preferences. It is also enhancing its brand connections with customers and trying to increase the productivity of its Chinese stores. In an encouraging sign, Nike’s future orders from Greater China rose by 4% in March 2013. While the recovery is expected to take some more time, we think the futures orders growth indicates demand is starting to pick up in Greater China.

Nike Will Face Headwinds In Western Europe and Japan

Nike is seeing mixed trends in the different markets of Western Europe. While demand is increasing in Northern countries including Germany and the U.K., Southern Europe (including Italy and Spain) continues to be challenging due to macro headwinds in the region. In Q4 2013, sales growth in this region will be impacted by difficult y-o-y comparisons, as sales in the previous year were driven by Euro Champs and Olympics. Future orders from this region fell by 5% in March 2013.

Japan could also prove to be a challenging market for Nike in Q4 due to currency headwinds. The recent devaluation of yen will affect dollar sales growth from the region.

Our $58 price estimate for Nike is around 5% lower than the current market price.

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