Sports giant Nike (NYSE:NKE) is scheduled to report its Q2 2014 results on December 19. (Fiscal years endwith May.) The company’s results in the previous quarter were encouraging on account of 7.7% year-over-year growth in the top line and expansion in gross margin. We expect revenue growth in high single-digit figures resulting from increased demand for Nike goods across all product types, categories and geographies.
We expect Nike to post strong results in North America, Central & Eastern Europe and emerging markets. Nike’s strategy to focus on discrete product categories (known as the category offense), coupled with the introduction of innovative, new products to its portfolio, will continue to fuel its future growth. In the last few quarters, Nike’s Chinese sales have been impacted by excess inventory in the region. The company’s revenues in China declined by 3%, but it saw 20% sales growth in stores that were retrofitted with more focused assortments. It will be interesting to see how much impact the knowledge leveraged from those stores and applied region-wide will have on sales in the broader geography this quarter. Strong sales are also expected from the Western Europe region.
Our $63.18 price estimate for Nike is around 17% lower than the current market price.
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The Result So Far
In fiscal Q1 2014, Nike’s revenues grew 8% on the back of broad based growth across several geographies and product categories. Its gross margin expanded 120 basis points due to higher net average prices and a shift in mix to higher margin products, which were partially offset by increased labor wages, higher discounts, currency headwinds and other factors.
In an overall move to bring down its operational expenses, the company has been expanding the higher margin direct-to-consumer division. The Nike Brand revenues in this division surged 18%, driven by a 9% increase in comparable store sales and a 12% rise in e-commerce sales. Nike brand footwear, apparel and equipment sales, which together account for about 85% of the company’s valuation, increased 9%, 9% and 13% respectively.
Category Offense Is Fueling Growth For Nike
Nike is focusing on individual product categories such as running, football, basketball, men’s training etc. to drive innovation and incremental sales in these product categories.
Running and basketball are two categories for Nike that are witnessing high growth and have strong market potential. The company is tapping growth in these categories by providing innovative technologies such as Nike Free, Lunar, Flyknit, Dri-Fit etc, and leveraging partnerships with leading athletes, such as Kobe Bryant, LeBron James, etc. We expect these two categories to continue to grow at a strong rate in the future.
a) North America represents the biggest market for Nike, accounting for around 42% of its revenues. The company continues to maintain a strong growth momentum in this market on account of factors such as continued innovation and superior marketing. Nike brand’s operating income jumped 26% in the first quarter of fiscal 2014, helped by strong sales growth, gross margin expansion and SG&A leverage, and we expect the company to achieve a similar performance in Q2 2014.
b) Emerging markets (excluding China) revenue rose 5% on a currency neutral basis, driven by strong growth in Brazil and Argentina in Q1 2014. This performance was partially offset by weaker results in Korea and Mexico. Weaker currencies were also a significant financial drag in the emerging markets geography, reducing the reported revenue growth figure to 1% and compressing gross margins. Emerging markets provide long term growth opportunity for Nike, and the company will leverage international sporting events such as FIFA World Cup and 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. Not only did the company’s sales jump 12% in the first quarter, the futures orders also stood at a promising 27% (in constant currency terms) at the end of August. Therefore, we believe this region will continue to be a strong growth driver for Nike in the near future.
c) 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 excess inventory and macro headwinds. The company is actively addressing this situation by clearing its excess inventory and by focusing its assortment with a greater level of precision on the sports and the products that are most preferred by Chinese consumers.
Nike has also setup 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 future orders from Greater China rose 3% in September 2013. While the recovery is expected to take some more time, we think the futures orders growth indicates demand is starting to pick up in Greater China (i.e. Mainland China, Hong Kong, Taiwan etc).
Outlook for Q2 2014
We expect to see gross margin expansion driven by higher average prices, lower raw material costs and growth in direct-to-consumer sales, partially offset by higher discounts to clear inventories in Mexico and China, start-up cost for expansion of distribution centers and stiffening currency headwinds. Expenses on demand creation and ongoing investments in strategic initiatives are also expected to eat into Nike’s profit margins. There will be more volatility in the year-over-year comparisons of margins due to the timing of key sporting events this year and last.