On Tuesday, Nike Inc. (NKE, Financial) reported financial results for the third quarter of fiscal 2020. Revenue for the quarter increased 5% to $10.1 billion (up 7% in constant currencies), compared to 9% growth in the first half of the year. Revenue increased in all regions except for Greater China, which reported a 5% year-over-year decline to $1.5 billion (constant currencies). This result, which follows 22 consecutive quarters of double-digit revenue growth for Nike in the region, was due to the impact of Covid-19 (coronavirus). As noted in the press release, sales in Greater China increased by double digits in the first two months of the quarter – implying a sizable double-digit decline in February. This largely reflects that, at the peak, roughly 75% of the company’s retail presence was closed in the region (today, more than 80% of all doors are open again).
While the brick-and-mortar business struggled as a result of the closures, the online business picked up the slack, with digital revenue in China up more than 30%. As management outlined on the call, they have seen continued improvement in the region as life has started to get back to normal. For the fourth quarter, they expect revenues in China to be roughly flat with the year-ago period. Combined with the reported year-to-date results, that implies full year (fiscal 2020) revenues of roughly $6.7 billion – an increase of 8% over 2019. Given what they’ve dealt with in that region over the past few weeks, I’d say that’s a pretty solid result. I’d also note that revenues in the region have still more than doubled over the past five years (17% compounded annual growth rate).
Importantly, Nike’s experience in China has also given them a battle-tested playbook as the virus spreads throughout other parts of the world, most notably in Europe and the United States. Just as in China, Nike’s business will lean heavily on digital to drive sales in the coming weeks (they’ve already closed all stores outside of Japan, China, and Korea).
Sales in North America during the quarter increased 4% to $4 billion. Adjusted for the sale of Hurley and a shift to a licensed business model with Fanatics, sales in the region increased by roughly 7%. While it’s all but certain that we’ll see a slowdown in the region as the U.S. deals with the effects of a sudden halt to the economy and store closures, the results from China over the past few weeks offer some hope that the effects will prove short-lived.
I would also note that, before the impact of the coronavirus took hold, Nike had strung together a few quarters of solid results. As management noted on the call, “Going into this, we were fortunately experiencing a very strong pull market for Nike globally, with some of the highest rates of full price sell through we have ever experienced.” In addition, the company has a strong balance sheet that will help it weather any short-term pain. (At the end of the third quarter, it had $7.4 billion in net current assets, inclusive of $2.9 billion in cash, and $3.5 billion in long-term debt). Personally, I am confident in the company’s ability to navigate the crisis.
One of the main reasons I say that was highlighted earlier: digital. Personally, I have come to believe over the past few years that this is one of the most important advantages that Nike has built relative to its competitors (supported by some bolt-on mergers and acquisitions as well). And I think it’s likely that the company will capitalize on the lead it has built in digital to further outpace the competition in the coming years. This commentary from Chief Finanical Officer (and soon to be chief operating officer) Andy Campion is worth thinking about:
“From a marketplace perspective, Nike Digital growth is accelerating amidst these dynamics. From a digital capability perspective, the investments we have made to date are now proving to be the foundation for our resilience amidst challenge and they will be strengths as we emerge. For example, we are leveraging Celect’s team and tools to dynamically model demand, pricing, planning and allocation. We are leveraging our Nike Membership platform and Nike Mobile App ecosystem to inspire and enable people to be active at home while also providing targeted product offers and services to consumers. And, the foundation we have built in Enterprise Data & Analytics is fueling our more agile end to end execution… we are still in the early innings of Nike’s digital transformation, but the capabilities we have been building for the future are proving to be the strongest pillars within our business today.”
While China is on the path to stabilization, its stumble is a headwind to short-term earnings. As I’ve noted in the past, Nike’s operating margins in China have approached 40% in recent quarters – roughly 1,500 basis points than what they’ve reported in North America.
As I think about the financials, it seems unlikely to me that 2020 earnings will be able to match what the company reported in 2019 ($2.5 per share). At a current price of $85 per share, that means the company is currently trading at nearly 35 times earnings.
That may prove appropriate if the company can consistently live up to its expectations of double-digit earnings per share growth. Personally, I need a more attractive price before I would consider adding Nike to my portfolio. We got there in the past week, but I didn’t move quickly enough. Hopefully Mr. Market will be kind enough to give me another shot at buying Nike. I would love to own this great business for the long term if the price was right.
And with that, I’ll let newly appointed CEO John Donahoe have the last word:
“We know it’s times like these that strong brands get even stronger. And I truly believe no one’s better equipped than Nike to navigate the current climate… Nike has a long history of rising to the occasion in extraordinary times, to deliver strong results and affect extraordinary change, in the world of sport and beyond. And that’s what we’re going to do once again.”
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