Oregon-based Nike (NKE, Financial) is the world's largest supplier of athletic footwear and apparel, as well as a major manufacturer of sports equipment. As of fiscal 2019, footwear accounted for more than 66% of total revenue, followed by apparel's 30%. Meanwhile, the company sold 68% of its dollar volume to wholesale customers and 31% through Direct to Consumer (i.e. company-owned retail stores and digital platforms). Per the latest filing, founder Philip Knight still keeps a 2.7% stake in the company.
We believe that Nike digs itself a wide and deep moat primarily through its highly-recognized global brand. In 2019, Interbrand ranked Nike 16th on its list of "Best Global Brands" - far above the closest competitor, Adidas (XTER:ADS, Financial), which ranked 53rd.
In addition, long-term partnerships with major sports leagues are believed to have further widened the brand moat over time. In 2017, Nike replaced Adidas as the NBA uniform provider for the following eight years. Then last year, MLB joined a 10-year uniform partnership with the company. In the meantime, Nike managed to extend its uniform deal with the NFL another eight years when the current contract expires this year. In our opinion, the Nike brand will be uniquely and "unfairly" benefiting from these highly scarce intangible resources that are going to be exclusive for the company in the years to come.
Furthermore, the scale of Nike's global operations also adds to the sustainable competitive edge. As you can see below, the company's operating margin has been consistently demonstrating cost advantages over Adidas and Under Armour (UAA, Financial) (UA, Financial).
We notice a similar outperformance in terms of free cash return on assets (see below), implying better capital allocation and the existence of the moat at Nike.
Moving forward, we think the Chinese market may pose a promising growth opportunity for Nike. Although only representing 17% of the company's fiscal 2019 revenue, the Greater China segment has grown by an over 20% rate year-over-year for recent years. With over $30 billion in annual sales, China's sporting goods industry is the second biggest market in the world, only behind the U.S. (around $105 billion). At the same time, the total sports-related industries in China account for a scant 0.7% of the GDP. Compare with the 3% contribution by sports to the U.S. GDP, and we can all agree on the massive runway ahead for Nike China.
When it comes to the business risk, the management expects "the rapid changes in technology and consumer preferences" to constitute significant risk factors in the operations, on which we cannot agree more. In the annual report, the company noted the following:
“Our success depends on our ability to identify, originate and define product trends as well as to anticipate, gauge and react to changing consumer demands in a timely manner. However, lead times for many of our products may make it more difficult for us to respond rapidly to new or changing product trends or consumer preferences. All of our products are subject to changing consumer preferences that cannot be predicted with certainty
...
While we strive to produce products that help to enhance athletic performance, reduce injury and maximize comfort, if we fail to introduce technical innovation in our products, consumer demand for our products could decline, and if we experience problems with the quality of our products, we may incur substantial expense to remedy the problems.”
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We own shares of Nike.
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