American sportswear company Nike (NYSE:NKE) recorded a strong 2013, with its stock price rising nearly 60% driven by strong performances across all divisions, product types and geographies. According to our analysis, the company is expected to record revenues of $27.7 billion in 2013, an ~12% year-on-year increase. Late in 2013, the company’s management announced its revenue target for 2017 – it expects to generate revenues of $36 billion by 2017.  One factor which will be crucial to the achievement of this target is the company’s brand apparel division. According to our analysis, this division is the second biggest contributor to Nike’s valuation, behind the footwear division. In this article, we take a closer look at the brand apparel division.
Our price estimate for NIKE stands at $67.49, implying a downside of ~15% to the market price.
What is Nike Brand Apparel?
Nike sells sports apparel and accessories in several sports categories, sports-inspired lifestyle apparel and athletic bags under the Nike brand. These products are essentially designed to compliment Nike footwear and are sold through the same marketing and distribution channels.
Apparel essentially includes jackets, caps, pants, t-shirts, sweaters, inner-wear, swimwear, shorts, socks, skirts, tops and belts. Men, women and children, especially those who fancy sports-inspired apparel are buying them across the world.
Key Drivers for this division:
Global Sports Apparel Market
The global sports apparel market is estimated to grow at a rate of 4% through 2019 and reach a total value of $135 billion. In comparison, Nike’s apparel sales have grown at a CAGR of 12.3% through 2010-2013, outpacing the industry-wide growth. We believe Nike’s apparel sales will continue to grow rapidly in the future driven by an innovative product portfolio, superior market position and enhanced marketing activities. We expect Nike to grab a 6.5% share of the market by the end of our forecast period. 
The key factors supporting our projection for Nike’s share in this market are as follows:
- Nike is currently recognized as one of the top sports brands in the world.
- Nike has several top sportsmen around the world as brand ambassadors. The company leverages the global appeal of these endorsers to create brand awareness and market its products.
- 39% of Nike’s apparel sales come from North America, where the company is an established market leader. Over the first half of fiscal 2014, apparel revenues from North America grew by 9%. We expect continued strong growth for Nike in this market driven by innovative product portfolio and superior marketing. 
- 14% of Nike’s apparel sales come from China, where the company has struggled in the recent past. In Q2 FY’14, Nike’s revenues from China grew by 4%, but apparel revenues grew by 8%. Given the company’s significant efforts at repositioning its brand in the region, it appears that Nike might finally have found the right strategy to gain a strong foothold in the Chinese sportswear market. The company expects low double-digit growth from China over the 2014-2017 period. We believe this target is a bit ambitious and revenue growth should come in around the high single digits. Nevertheless, we expect sales in China to be driven by the company’s brand apparel. 
- 29% of Nike’s apparel sales come from Europe. In the first half of fiscal year 2014, apparel sales grew by 4% in Western Europe and 13% in Central and Eastern Europe. With reported future orders growth of 26% and 13% from the regions respectively, we expect this strong growth rate to continue in the second half of fiscal 2014. 
The gross profit margin for Nike’s brand apparel division declined by 2.4% to reach 44.1% in 2011. The decline was primarily driven by higher product input costs, including materials and labor, which more than offset the positive impacts of higher product selling prices, as well as the growth of its direct-to-consumer business and benefits from ongoing product cost-reduction initiatives. In 2012, the gross margin further declined to 43.2% on account of higher input costs and an unfavorable currency impact. Moreover, the steps taken by Nike to clear its excess inventory in China by offering discounts further affected its margins. Going ahead, we expect margins to gradually increase in the future and surpass 45% in the long run.
The key factors supporting our projection for Nike brand apparel’s EBITDA margins are as follows:
- Cotton is one of the key raw materials used in the manufacturing of apparel products. Cotton prices peaked at around $2.30 per pound in March 2011, on account of drought in major cotton producing areas of China coupled with export restrictions in India and flood conditions in Pakistan. Since then, cotton prices have declined and they were recorded at around $0.80-0.90 per pound in March 2013. We expect the upside in cotton prices to be limited in the near term, owing to high global inventories and lower consumption of cotton, factors expected to bode favorably for Nike’s input costs.
- While the impact of rising commodity and transportation costs are likely to weigh on all footwear and apparel manufacturers, Nike’s status as market leader could allow the company to withstand these pressures more effectively. Nike sets apparel prices a few months in advance of distribution, so any near-term price declines could stem from a misjudgment of input cost increases. Going forward, Nike can leverage its brand recognition to raise prices and offset further cost increases. Price rises will positively impact margins.
- With increasing contribution of Nike’s Direct-to-Consumer business, the company’s dependence on licensing partners and wholesale distributors will decline. This will help improve margins by eliminating the commissions and margins offered to middlemen.
- A mitigating factor could be rising labor costs in China. Nike’s manufacturers are distributed evenly across China, Vietnam and Thailand. Labor costs in China have increased, a trend that could raise production costs and reduce gross margins for Nike. If the company isn’t able to pass on these rising input costs to the consumer, it might have to think about shifting its suppliers to some place with low labor costs like Cambodia.
- Nike Targets $36 Billion in Revenues by Fiscal 2017, Business of Fashion, October 2013 [↩]
- Why Nike Will Outpace The Sports Apparel Market’s Growth, Trefis, May 2013 [↩]
- Nike CEO Discusses F2Q 2014 Results, Yahoo Finance, December 2013 [↩] [↩] [↩]