Nike (NKE) posted fiscal second-quarter results, which, by most measures, was in line with our expectations. Top line revenue grew 18%, thanks to both slightly higher prices and impressive unit growth.
Though sales in most segments showed solid improvement, earnings growth was not nearly as impressive. Gross margins fell well over 200 basis points to 42.7%, their lowest margins in several years. Due to production times and hedging, Nike won’t experience the benefit of lower input costs until late in its fourth quarter of early fiscal year 2013. With high cotton prices, high rubber prices, and high fuel costs hitting the books, we think gross margins could suffer in the back half of this year (fiscal 2012) as well.
As a result of lower margins, net income only grew by 3%, but earnings per share grew by 6% as a result of substantial share buybacks. Inventory also grew by 39%, but management attributes only 20% of this increase to unit growth, while the rest of the increase caused by higher costs.
This high inventory growth is consistent with what we’ve seen from the rest of our athletic apparel universe. Lululemon (LULU) saw its inventory nearly double, and Under Armour (UA) also saw inventories rise by 64% (versus 42% sales growth). We think this inventory growth has one very important implication. With higher inventory costs, the importance of higher average selling prices (ASP) cannot be underestimated. Prices will need to remain high for margins to hold up, or at least not fall while the higher priced inventory comes off the books. Missteps in operations could lead to substantial markdowns that hammer the bottom line for these firms.
In the interim, the rest of Nike’s fiscal year has some positive catalysts. In the current quarter, we are seeing strength in sales of high-end basketball product, particularly Jordan Brand Retro shoes and the LeBron 9, in spite of the fact that the NBA hasn’t started playing yet. We’ve also seen continued strength in core apparel at places like The Sports Authority and Dick’s Sporting Goods (DKS). Additionally, Nike acquires the NFL apparel license in April of 2012. Though the NFL ratings have never been stronger, we’ve seen some surprising weakness in jersey sales, which we attribute to consumers getting tired of poor Reebok apparel and even some people waiting for Nike to take over. We think Nike could bring some fresh products and innovation to NFL apparel, driving sales increases for the
Furthermore, Euro 2012 and the
Ultimately, the athletic apparel market has been hot over the past several quarters. Though we think Nike is fairly valued, we think it’s among the best choices for investors looking for exposure to