Earnings Preview: Higher Unit Prices, Shift To Higher Margin Businesses To Drive Nike’s Growth

Sports giant Nike (NYSE:NKE) is scheduled to report its earnings for the second quarter of fiscal 2015 on Thursday, December 18th. In the previous quarter, the company recorded a 15% revenue growth over the same quarter in the previous fiscal period, along with an expansion in gross margin of 170 basis points. ^[1] Nike delivered strong growth across its product portfolio in fiscal 2014 and we expect these strategies to continue delivering growth in fiscal 2015. However, the company expects the  momentum to slow down in the second quarter of fiscal 2015.  Additionally, incremental investments in the company’s Direct to Consumer business, should help boost the operating margins of the company.

Nike has guided for a high single-digit growth in revenues for the second quarter of fiscal 2015, with a 120-150 basis point expansion in gross margin, on account of a shift to higher margin products in the sales mix and improved performance of its higher margin businesses. The company expects its overhead expenses to rise owing to investments undertaken by the company in its DTC business and e-commerce channel. ^[2] We expect the company’s earnings to be in line with its guidance for the reasons cited by the company.

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Recap of Q1 FY15 Results

In the first quarter of Fiscal 2015, Nike’s revenues from continuing operations were up by 15% on a reported and currency neutral basis. Gross margin increased 170 basis points to 46.6 %, driven by a sales mix of higher margin products and businesses, higher average prices, lower input costs, and continued strength in the higher margin Direct-to-Consumer business. The company’s strong performance in Q1 2015 was underscored by high growth in North America and Europe. High demand in running, basketball, and football categories continue to fuel the growth momentum for Nike. The company’s performance in China also provided much reason for cheer as the revenue from the region grew by 18% on a currency neutral basis in Q1 2015 compared with the 2% growth in the previous quarter. The company’s outlook on this market in 2015 continues to be optimistic. ^[3] Revenue for Nike Brands from the DTC channel grew 30% driven by 15% comparable store growth and an impressive 70% growth in online sales. ^[2]

Regional Performances

North America represents the biggest market for Nike, accounting for ~40% of its revenues. The company is the market leader in the North American athletic footwear market, with nearly 60% market share. Moreover, sales in the footwear category are driven by the basketball category, which has higher margins than other footwear categories. Nike’s strong footwear performance is based on using endorsements by iconic figures such as Michael Jordan and Kobe Bryant to sell its products. New endorsement deals, such as those with Lebron James and Kevin Durant, should help Nike retain the same strength over the coming quarters. Additionally, the strength of the company’s growing Direct-to-Consumer business should ensure that sales in this region remain solid.

Emerging markets (excluding China) revenue grew by 10% in the previous quarter. The growth rate was lower than expected due to the weakening of the Brazilian economy and supply chain issues faced by the company in Mexico. Emerging markets provide long-term growth opportunity for Nike, and the company will leverage international sporting events such as the 2016 Summer 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 reported a sales jump of 7% in the first quarter with futures orders growing at a promising 11% (in constant currency terms) at the end of Q1. Therefore, we believe this region will continue to be a strong growth driver for Nike in the near future. ^[2]

China is expected to hold the key to Nike’s future growth, owing to its large population and a fast growing economy. However, Nike’s Chinese sales have been hit in the recent past due to ineffective brand positioning, which led to a long drawn out process of clearing out excess inventory by offering discounts. The company is actively addressing this situation by focusing its assortment with a greater level of precision on sports and products that are most preferred by Chinese consumers.

Nike has also set up new distribution centers and increased its marketing capacity in the region. The sales figure in the face of this restructuring process will be a key indicator of Nike’s health in China. In an encouraging sign, Nike’s revenues from  Greater China rose 18% in Q1. ^[2]However, the trajectory of growth in sales from Greater China is unlikely to be linear, as shown by only 5% growth in reported future orders. ^[1]

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1. NIKE’s F1 Q2015 Results, Businesswire, September 2014 [↩] [↩]
2. NIKE’s CEO discusses F1 Q2015 Results, Seeking Alpha, September 2014 [↩] [↩] [↩] [↩]
3. NIKE’s CEO discusses F4 Q2014 Results, Seeking Alpha, June 2014 [↩]