Nike Continues to Innovate and Create Value for Shareholders

We may sound like a broken record, but Nike (NKE) reported another strong quarter Thursday. In its fiscal third quarter, sales grew 15% to $5.8 billion from $5 billion, and earnings per share grew 11% to $1.20 from $1.08 in the year-ago quarter. Both the top line and bottom line came in better than consensus estimates, even with the firm’s gross margin falling 200 basis points from a year ago. All things considered, performance was about what we had expected, and our fair value estimate for Nike remains unchanged.

North American Future Orders were up 22%

As Nike Brand president Charlie Denson said on its fiscal third-quarter conference call, “If I hadn’t been working here for the last 33 years, I’d swear North America might even be considered an emerging market.” Revenue for the third quarter grew a whopping 17% in North America, barely trailing the growth in China and from its Emerging Markets segment. Though the pace of orders and revenue growth are not perfectly correlated, we think such a large number in North America is a great sign for the firm’s future growth trajectory. However, it‘s important to remember that this number likely includes the new NFL license (an entirely new revenue segment) that will be rolled out the first weekend of April. It also includes several modest price increases over a year ago, which we think will help gross margins in North America going forward, despite the shortfall in the most recently-reported period.

Demand for NFL products “exceeded all of our expectations”

For a behemoth like Nike, the NFL license won’t really move the needle as much as it would for a company like Under Armour (UA). Still, we like the deal, and we’ve noticed a lot of buzz around message boards and sports fans about how the “new” jerseys will look and fit. Perennial top-sellers Tim Tebow and Peyton Manning jerseys will be in high demand after each moved teams, and we think new comers like Andrew Luck and Robert Griffin III will invigorate loyal fan bases.

Further, we think Nike will leverage the license to increase sales of everything from mouthguards to running shoes. Nike is the Apple (AAPL) of athletic apparel, so we wouldn’t be surprised to see them capitalize on a multitude of cross-selling opportunities.

Inventories are up 32%…

As much as we liked the quarter, inventories did grow substantially. Management was upfront with the issue, which they attribute to a shift in product mix and higher raw costs. While we think this is true, as management cited only around a 12% unit increase, we will continue to monitor the situation and update investors immediately if our views change.

Some of the growth in inventory was attributed to apparel build in China and Central Europe. Management addressed this issue by stating that they will be aggressive about moving products (read: markdowns). This actually leads in nicely to another weakness: apparel sales in China were only up 6% in constant currencies, but footwear was up 30%.

China’s enormous growth in footwear consumption is consistent with our belief that Nike is the best footwear company in the world. However, it’s a little troubling that the firm  isn’t leveraging the footwear success into apparel revenues. It seems possible that Chinese consumers just aren’t as interested in specialty athletic apparel in the same way that Americans are. With adidas (ADS) lapping poor results the past few years and Under Armour lacking any presence in China whatsoever, it’s difficult to tell if this is a Nike issue or a market issue.

The rest of the year looks promising

Admittedly, it’s hard to get too excited about a company as huge as Nike after shares have already run up 44% over the past year. Nike’s also trading near the top-end of our fair value range. However, Nike is still a best-of-breed company that deserves to trade at a premium multiple as long as the firm continues to meet our cash-flow projections and executes effectively. If shares do happen to fall in the low $90’s (the lower end of our fair value range), we would consider adding Nike to the portfolio in our Best Ideas Newsletter on improving technicals.