Earnings Review: Strong Performance In Europe And North America Keeps Nike On Growth Track

Sports giant Nike (NYSE:NKE) recorded another strong quarter in Q4 2014, with revenue rising by 11% annually to $7.4 billion. Gross margin expanded by 170 basis points y-o-y, helped by higher average selling prices and continued growth in the higher margin direct-to-consumer (DTC) business, which were partially offset by an increase in input costs and unfavorable currency translations. The company’s strong performance in Q4 2014 was underscored by high growth in North America, Western Europe and Emerging Markets(excluding China). High demand in running, basketball and football categories continue to fuel the growth momentum for Nike. Sales of Nike brand apparel and sporting equipments fell in China, resulting in a 12% decline in earnings before taxes from the Greater China region. Nike Brand DTC was up 27% for the quarter, putting annual revenues for the segment beyond the $5 billion mark, close to 20% of the company’s total revenues. ^[1]

For the full fiscal year 2014, revenue from continuing operations was $27.8 billion, up 10% compared to the previous year. Gross margin expanded by 120 basis points year-on-year largely due to higher average selling prices and a higher contribution of the DTC business to the company’s overall revenues. Late last year, the company announced a fiscal year 2017 revenue target of $36 billion. ^[2]As part of this target, the company hoped to raise DTC revenues to $5 billion by fiscal year 2015, but thanks to strong results in its inline and factory stores as well as online, it has achieved the target a year earlier.

We are in the process of revising our $68 price estimate for Nike’s stock.

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North America Continues To Be Strong

Nike recorded its most profitable year ever in North America with reported earnings before interest and tax rising faster at 14% than reported revenues(10%). For the fourth quarter, North America revenue also grew 10% led by double-digit growth in basketball and global football.  DTC revenue grew 21% driven by an 8% increase in comparable store sales and significantly higher revenues from its e-commerce website. ^[3]

The remarkable performance in this geography shows the strength of the Nike brand as it has managed to capture the growth in the market and take market share from an ever rising number of competitors at the same time. The company is a market leader in the basketball and running categories, and leverages the insight gained from those segments to capture the significant growth opportunities in areas like e-commerce, apparel, women’s and young athletes businesses. Nike applies discrete strategies to individual segments, identifying the opportunities in each category and applying different strategies to capitalize on these opportunities, instead of applying a one-size-fits-all strategy common to the sportswear market.

China Still Sluggish

In line with our expectations, sales in China only grew by 2% for the quarter. For the full year, revenue growth came in at 3%. At $2.6 billion in annual revenues, China contributes less than 10% to the company’s top line. Given that China is one of the largest markets for athletic footwear and apparel in the world, the geography provides a significant growth opportunity for Nike. We have already written about the problems Nike faces in establishing a strong foothold in this market. (See: Nike’s China Problem)

Previously beset by the accumulation of unsold inventory and indifferent response to new product launches, Nike decided to reset its strategy for China in fiscal 2014. The company believes that it has made good progress on that front and expects to achieve sustainable double-digit growth from the region soon. In 2014, Nike tested new merchandising concepts in China, which drove comparable store sales for the quarter up 22%. ^[3] The sports retailer also changed the assortment of inventory it sells to wholesale partners in China, undertook the re-profiling of multiple stores in the region and reduced the levels of inventory considerably. However, these newly re-profiled stores only form a small part of Nike’s business in China, and any profitability gains made from these stores are likely to be offset by the expenses the company undertakes in the re-profiling of the rest of its stores. Therefore, we do not expect the region to be profitable before interest and taxes anytime soon.

Europe Continues To Surprise

Nike brand revenues in Western Europe grew by 18% (in constant currency terms) in Q4 2014, further confirming that Nike is gaining ground over market leader Adidas. Similar to the operations in China, Nike undertook a rebasing of its operations in Europe two years ago. The company introduced shop-in-shop concepts at sports retailers like JD Sports, Foot Locker and Intersport, in addition to trying out new store concepts in its own retail stores and online. The strategy has been successful, with Nike now the leader in the footwear market in all countries key to its business in Europe and is the preferred sports brand in each of the top 10 cities in Western Europe. For the full year, earnings before interest and taxes grew by a third in Western Europe, more proof that the company is gaining significant returns on its investments in the region. Nike brand revenues in Central and Eastern Europe saw 12% annual revenue growth in Q4 fueled by high demand in Russia, Poland, Greece and Turkey. ^[3] We expect high growth in this market in fiscal 2015 due to growing economic prosperity in the region. Recent futures order growth at 14% (in constant currency terms) supports our outlook. ^[1]

Outlook for Q1 fiscal year 2015

The company issued the following guidance for the first quarter of fiscal 2014:

• Revenue to rise at a high single-digit rate, driven by events such as the FIFA World Cup in Brazil and continued growth in North America and Western Europe.
• Q1 gross margin to be 75 basis points higher than previous year due to a shift in mix to higher margin products as well as ongoing strength in the higher margin DTC business.
• SG&A expenses will increase by 30% on account of higher marketing expenses related to the FIFA World Cup. ^[4]

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1. NIKE, Inc. Reports Fiscal 2014 Fourth Quarter and Full Year Results, Businesswire, June 2014 [↩] [↩]
2. NIKE, INC. ANNOUNCES TARGET FOR FY17 REVENUES OF $36 BILLION, nikeinc.com, October 2013 [↩]
3. NIKE’s CEO discusses F4Q2014 Results, Seeking Alpha, June 2014 [↩] [↩] [↩]
4. NIKE’s CEO discusses F4Q2014 Results, Seeking Alpha, June 2014 [↩]