Nike NKE recently reported financial results for its first quarter of fiscal 2021. Revenue declined 1% to $10.6 billion, with a 4% increase in footwear offset by a high-single digit decline in apparel. While this was a disappointing result relative to the high-single digit revenue growth that investors have come to expect, it was a meaningful improvement from the fourth quarter of fiscal 2020, when revenues declined 36%. The company's Direct revenues increased low-double digits to $3.7 billion, led by an 82% increase in digital revenues (and triple digit growth in Nike's app monthly active users). As CEO John Donahoe noted on the conference call, the recent results support the conclusion that Nike is building a sustainable competitive advantage in this channel:
"Nike's digital transformation strategy is not easily replicated. Simply put, scale matters… Our size, our incredible product, our brand strength, the direct consumer relationships we deepen each day, and our ability to create seamless and differentiated shopping experiences, is how we drive continued separation."
By region, revenues declined by 2% in North America and by 18% in Asia Pacific & Latin America (APLA), offset by mid-single digit growth in Greater China and in Europe, the Middle East & Africa (EMEA). In North America, despite the revenue declines, I think investors can be encouraged by the change in mix. Specifically, digital revenues nearly doubled year-over-year in North America. In addition, as the company has highlighted on recent calls, their strategy is focused on working with wholesale partners who align with Nike's long-term vision. Given that, it was encouraging to see that sales through strategic wholesale partners (retailers like Dick's Sporting Goods DKS) increased high-single digits in the quarter, offset by a greater than 20% decline in undifferentiated channels (retailers like Macy's M).
Following a low-single digit decline in the fourth quarter, it was also encouraging to see the Greater China business return to growth (+6% reported, +8% in constant currencies). This is an increasingly important region for Nike, accounting for roughly 17% of the company's revenues in the quarter and an outsized percentage of profitability (in recent years, the Greater China has consistently reported profit margins that were meaningfully higher than the rest of the business). As shown below, assuming 10% growth for the year, Greater China will report roughly $7.4 billion in fiscal 2021 – significantly more than the $2.1 billion in revenues generated in the region a decade ago.
Despite the meaningful mix shift to digital in the period, which management has stated can deliver roughly 10 points of higher margins over wholesale in a normalized environment, gross margins declined by 90 basis points in the quarter, to 44.9% (and that's inclusive of a 55 basis point one-time benefit). The year-over-year decline in gross margins reflects the impact of the pandemic, most notably the need for higher promotions to reduce excess inventories (as noted on the conference call, management expects inventory levels to normalize in the next few months).
Impressively, Nike reported meaningful growth in operating profits (+13% to $1.8 billion) along with a 220 basis point expansion in operating margins to 16.7% despite lower gross margins. That reflects an 11% year-over-year decline in selling, general and administrative expenses (SG&A), with some questions about the sustainability of those declines (it's my understanding that some of these cost reductions simply reflect the cancellation of sporting events, which will naturally reverse in the coming months). That said, management is making the case to shareholders that the company, in the years ahead, will be in a position to leverage marketing spend more effectively than they have in the past. For example, consider these comments from chief financial officer Matthew Friend:
"The third piece ties back to what I referenced on our performance marketing investment. We have to move deeper into the funnel, moving from attracting and acquiring new members to retaining members, knowing those members and driving more engagement and frequency of purchase within our existing member base. And we believe that by running that offense, we will see more productivity in our demand creation spend and a higher return on our demand creation spend. And by doing that, we should be able to also drive additional operating margin expansion."
Personally, I remain a bit skeptical on this point. While I understand the point Friend is making, I also wonder whether this becomes table stakes over time in the industry. In addition, as shown below, Nike has not delivered any material improvement in operating margins as the digital mix increased from ~0% to ~30% over the past ten-plus years. For these reasons, while I appreciate the arguments made, I'm not willing to apply a high degree of certainty to the notion that Nike's operating margins in 2025 or 2030 will be meaningfully higher than they are today.
Conclusion
Nike continues to fire on all cylinders. As Donahoe noted on the call, while many companies have just been focused on surviving over the past six months, Nike is continuing to move forward. With that said, I cannot bring myself to pay today's valuation. At a current price of $125 per share, the stock is trading at roughly 50 times 2019 earnings of ~$2.5 per share, well above the price-to-earnings that Mr. Market has attributed to this company on average over the past decade.
Is some of that deserved? Yes, I think it is. Simply put, I agree with management: Nike is in a better position to compete and win long-term in the digital business than some of its peers. That said, I'm not sure it justifies a price-to-earnings ratio of 50 times earnings, compared to 20 or 25 times earnings a few years ago. As I've said before, I would love to own Nike at the right price – but I don't think that price is $125 per share. For that reason, I'll remain on the sidelines until that changes.
Disclosure: None
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