Earnings Preview: Rising Costs Could Impede Nike’s Momentum This Quarter

Sports giant Nike (NYSE:NKE) is scheduled to report its earnings for the fourth quarter of fiscal 2015 on Thursday, June 25th. In the previous quarter, the company reported a revenue growth of 7% to $7.5 billion. The company’s strong performance in Q3 2015 was underscored by high growth in North America, Western Europe, and Greater China. High demand in running, basketball, and football categories continue to fuel the growth momentum for Nike. Additionally, Nike Brand DTC was up 29% for the quarter. ^[1]

Nike had guided for a high single-digit growth in revenues for the second half 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.

See our complete analysis for Nike

Recap of Q3 FY15 Results

In the third quarter of Fiscal 2015, Nike’s revenues from continuing operations were up by 7% on a reported and currency neutral basis. The gross margin expanded by 140 basis points year over year, driven by a shift in the sales mix to higher margin products and continued growth in all product types and geographies.  Also contributing was strong growth in the higher margin direct-to-consumer (DTC) business, though an increase in input costs partially offset by partially offset the aggregate improvement. The company’s strong performance in Q3 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 exceeded our expectations this quarter. In the previous quarter, China revenues grew by 17%. 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) But Nike’s strong performance over the past two quarters has helped Nike achieve the leading position in both the athletic footwear and apparel markets.

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.

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 17% in Q3. ^[2]   However, the trajectory of growth in sales from Greater China is unlikely to be linear as the Chinese market faces the effects of an economic slowdown.

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1. NIKE, Inc. Reports Fiscal 2014 Third Quarter Results, Business Wire, March 2014 [↩]
2. NIKE’s CEO discusses F1 Q2015 Results, Seeking Alpha, September 2014 [↩] [↩]