Nike Earnings Preview: China And Europe Could Offset N. America Growth

Sportswear giant Nike (NYSE:NKE) is scheduled to announce its Q3 2013 results on March 21. In Q2 2013, its revenues grew by 7% annually to reach $5.9 billion. However, its gross margin declined by 30 basis points annually in Q2 2013 to 42.5%, mainly on account of increase in labor costs and unfavorable currency impact.

We expect Nike’s top line in Q3 2013 to be driven by continued growth in North America and the emerging markets. These markets have recorded strong sales growth in the recent past, and we expect the trend to continue in this quarter. However, weakness in China and Western Europe could present headwinds to the company’s top-line in Q3 2013, as high inventory levels in China and economic problems in Europe continue to present challenges for Nike. We think Nike’s actions to clear its excess inventory in China, coupled with rising labor costs and unfavorable currency impact could weigh on its gross margins in the quarter.

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Growth Is Expected to Be Led By Higher Demand From North America And The Emerging Markets

North America represents the biggest market for Nike, accounting for around 42% of its revenues. The company has posted strong sales growth in the region over the past few quarters. In Q1 2013 and Q2 2013, Nike brand’s North American revenues grew annually by 23% and 17% respectively. Double-digit sales growth across footwear, apparel and equipment, and several categories including running, basketball and men’s training, underscored this strong performance. We think Nike will be able to continue its momentum in the North American market in Q3 2013, on account of its superior brand image and strong marketing strategy.

Emerging markets, which contribute for around 16% of Nike brand revenues, represent another growth region for Nike. In Q1 2013 and Q2 2013, revenues from the emerging markets showed an annual constant-currency growth of 22% and 18% respectively. Nike is increasingly gaining traction with consumers in emerging markets such as Brazil, Mexico and Argentina, and we expect revenues from these regions to grow at a strong pace in Q3 2013.

Weakness In China And Western Europe Could Impact Nike’s Growth

China represents a long term growth driver for Nike as the athletic apparel and footwear market is growing rapidly in the region on account of growing middle class and increasing fitness trend among consumers. While Nike has historically witnessed high sales growth in Greater China, recently it has faced certain challenges in the region. Its revenues from Greater China dropped by 11% annually in Q2 2013, as compared to 23% growth in fiscal 2012. Weakness in the Chinese economy coupled with high inventory levels in the marketplace contributed to the decline in sales growth.

According to the company’s guidance, the Chinese market will continue to be beset with problems for a few quarters, including Q3 2013. However, Nike is actively taking steps to recover its growth pace in the region. Over the short term, it is focusing on managing its inventory level in the market, and for the long run, it is improving its product portfolio to align them with Chinese tastes and preferences. It is also improving the productivity of its stores and bolstering its brand awareness in the region. Since Nike has more than 30 years of experience in the Chinese market and holds a leading position in the market, we believe Nike could return to sales growth in China over the long run. The demand from Chinese consumers is expected to grow in the future, and high inventory and macro-headwinds are short term trends which may not persist for a long period.

Weakness in Western Europe represents another headwind for Nike. Nike brand revenues from this region declined by 2% in Q2 2013, on account of macroeconomic challenges as well as unfavorable currency impact. Southern Europe has been particularly affected by weaker economic conditions, and we think revenue growth from this region could remain slow in Q3 2013.

Expansion In Direct-To-Consumer Sales To Continue

Nike has been focusing on its direct-to-consumer sales to grow its business. Nike brand sales through direct-to-consumer channel, rose by 21% and 25% annually in Q1 2013 and Q2 2013 respectively. Moreover, the share of direct-to-consumer sales in total Nike brand revenues increased to 18% in the first six months of fiscal 2013, as compared to 16% in the prior year. We expect sales growth through direct-to-consumer channel to outpace sales growth through wholesale channel in Q3 2013.

Our $56 price estimate for Nike is broadly in line with the market price.

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