Image Shown: Shares of Nike sold off moderately on June 26 after reporting its full-year earnings for fiscal 2020 (period ended May 31, 2020), though please note shares of NKE have rebounded sharply from their March 2020 lows. Over the past year shares of Nike are still up ~15% as of this writing, outpacing the 4% gain seen at the S&P 500 (SPY) before taking dividend considerations into account.
By Callum Turcan
Retailers of consumer discretionary products that invested heavily in their digital presence and direct-to-consumer sales/distribution systems before the coronavirus (‘COVID-19’) pandemic put themselves in a much better position to ride out the storm. Nike Inc (NKE) reported that its digital sales in the fourth quarter of fiscal 2020 (period ended May 31, 2020) rose by 75% year-over-year (up 79% on a constant-currency basis) and represented roughly 30% of its total revenues last fiscal quarter. Management cited rising online engagement at the firm’s Nike Training Club app and other past digital investments as signs that Nike’s strategy is working. Here’s a slightly edited excerpt of what the firm’s management had to say during Nike’s latest quarterly conference call (emphasis added):
“This quarter was certainly like no other in Nike’s history… Digital quickly became the primary channel that we could engage with and serve consumer demand, and Nike was well positioned to respond. We accelerated growth of our digital business to 79% on a currency neutral basis and drove nearly triple digit acceleration in member digital demand. All told Nike digital represented nearly 30% of our total business in the fourth quarter, and reached $5.5 billion for the full year…
In [fiscal] Q4, we already pivoted our new adaptive distribution facility in North America to fully support digital demand. And we plan to open a new regional service center on the West Coast before the holiday season to forward deployed digital inventory, leveraging advanced analytics and demand sensing capabilities from our acquisition of Celect…
…a more digitally connected Nike is a more valuable Nike. The underlying value proposition of Nike’s Consumer Direct Offense is that the consumer adoption of digital across all aspects of life now provides Nike with an opportunity to create deeper, more direct to consumer relationships at scale… As we’ve said before, the transformation to a more digital and direct business is financially accretive to Nike.” — Matthew Friend, CFO of Nike
In August 2019, Nike acquired the predictive analytics and demand modelling firm Celect, though financial terms were not disclosed. As Nike gets a better understanding of its customer base through its direct-to-consumer businesses (Nike Store, Nike App), the firm will be able to adapt faster to changing consumer trends and that in turn will allow for Nike to further optimize its supply chain. Better inventory management practices should put upward pressure on Nike’s gross and operating margins over time. That is on top of the potential upside Nike could generate by creating a closer connection (e.g. the consumer using Nike’s training or running apps on a consistent basis) between its operations and its customer base in terms of sales growth.
Overview
Though Nike’s digital and direct-to-consumer strategies are playing out well, relatively speaking, the retailer’s GAAP revenues still fell by 38% year-over-year last fiscal quarter. A combination of physical store shutdowns as part of broader pandemic containment efforts seen worldwide and changing consumer spending patterns in the US and elsewhere (spending on consumer staples products surged while spending on consumer discretionary products tanked in many nations) put a tremendous amount of pressure on Nike’s top-line performance (as expected). The company missed both consensus top- and bottom-line estimates last fiscal quarter as its digital strength was unable to offset heavily subdued in-store sales.
Demand for footwear, apparel, sports equipment, and related accessories took a beating in North America during the early stages of the COVID-19 pandemic. The US Census Bureau reported that domestic sales at ‘clothing & clothing accessories stores’ were down 63% year-over-year in the month of May 2020 on an adjusted basis. For the month of April 2020, data from the US Census Bureau indicates sales at clothing & clothing accessories stores were down 87% year-over-year on an adjusted basis. Forced closures of retail properties due to stay-at-home orders and other pandemic containment efforts were the main culprit, however, we caution that elevated unemployment rates in the US and elsewhere will weigh negatively on consumer spending power going forward.
Shares of NKE moved significantly lower on June 26. That being said, shares of NKE are still up ~15% over the past year as of this writing while the S&P 500 (SPY) is up ~4% during this period, before taking dividend considerations into account. Investors have rewarded Nike for its ability to adapt to changing consumer trends while dealing with the hurdles created by the pandemic, seen through its share price recovering sharply from their March 2020 lows. The top end of our fair value estimate range sits at $92 per share of NKE, indicating to us that the recent pullback in Nike’s share price is a sign that the market recognized it had gotten ahead of itself here given the headwinds facing consumer discretionary spending worldwide.
Quarterly Update
In the fourth quarter of fiscal 2020, Nike’s GAAP gross margin fell by over 820 basis points year-over-year as the pandemic took its toll. Nike offset some of those headwinds by reducing its operating expenses by 6% year-over-year, largely due to its ‘demand creation’ expenses falling by 19% year-over-year while Nike’s other overhead expenses were down marginally year-over-year.
Management noted that “our current focus is to reduce discretionary spending, while we invest in the digital capabilities necessary to further our competitive advantage in the marketplace.” Specifically, Nike intends on “managing SG&A tightly” in order to “prudently manage costs in the short-term, while we scale investment in key capabilities underpinning our digital transformation” during the first half of fiscal 2021 (and likely beyond).
Operating expense reductions were not enough to stop Nike from posting a GAAP net loss of $0.8 billion last fiscal quarter as its operating expenses still outstripped its gross profits. As worldwide consumer spending shifted towards consumer staples products and US household savings rates shot up in the months of April and May this calendar year, Nike’s financial performance was obliterated by a vicious combination of declining revenues and gross margins.
Going Forward
Looking ahead, the easing of containment efforts worldwide and the sustained momentum at its digital sales channels paints a more optimistic picture for Nike. The company’s management team specifically noted the company was seeing very strong momentum in the ‘Greater China’ region and had this to say during this firm’s latest quarterly conference call:
“Greater China returned to growth in [fiscal] Q4 and Nike digital also accelerated growth each month in the quarter, including triple digit growth globally in May even as physical retail reopened. These trends have sustained through the first three weeks of June. And in some markets digital growth has accelerated even further.
We believe this digital acceleration is more indicative of a strategic shift towards a new future marketplace, rather than being a reflection of temporary challenges to the mostly physical marketplace of the past.” — CFO of Nike
In the fiscal fourth quarter, Nike’s Greater China revenues were down just 3% year-over-year after falling 5% year-over-year in the fiscal third quarter. Management noted that Nike “returned to growth” in this region last fiscal quarter which seems to imply that the retailer’s sales trajectory in the Greater China region should improve sequentially in the first quarter of fiscal 2021. For contrast, Nike’s ‘North America’ revenues were up 4% year-over-year in the fiscal third quarter but down 46% year-over-year in the fiscal fourth quarter. Nike’s digital strength in the Greater China region played a huge role in supporting its revenues during these harrowing times. All of Nike’s company-owned stores in the Greater China region were open as of late-June.
Going forward, management noted that Nike had “increased digital fulfillment capacity by more than 3x in North America and EMEA [Europe, the Middle East and Africa]” which will better enable the firm to meet consumer demand in a timely fashion. Approximately 85% and 90% of Nike’s company-owned stores were open in the North America and EMEA regions, respectively, as of late-June. In the ‘Asia Pacific & Latin America’ region, about 65% of its company-owned stores were open as of late-June. Please note a lot of third-party retailers also sell Nike products, and the pace of those stores reopening will play an important role in Nike’s near-term performance.
As of May 31, 2020, Nike had a cash, cash equivalents, and short-term investments balance of $8.8 billion versus $0.3 billion in short-term debt and $9.4 billion in long-term debt. We like Nike’s strong balance sheet and view its modest net debt position as very manageable.
Nike’s inventory balance rose by 31% year-over-year last fiscal quarter, hitting just below $7.4 billion. Management was confident that by the second quarter of fiscal 2021 the firm’s “inventory will be right sized and in a normal position” which will be accomplished in part through “targeted promotions and markdowns to accelerate the liquidation of excess inventory.” That indicates Nike’s gross margins will face some headwinds in the near-term, though potentially favorable working capital movements could bolster its net operating cash flows. We will have more to say on Nike’s financial performance, with an eye towards its cash flow position, when the firm publishes its 10-K Annual Report for fiscal 2020.
Concluding Thoughts
Nike is performing well operationally as its digital strategy has helped mitigate some of the headwinds created by the ongoing pandemic. The retailer’s strong balance sheet provides ample support to ride out the storm while being able to maintain its current dividend policy. Shares of NKE yield ~1.1% as of this writing, and we give Nike an “EXCELLENT” Dividend Safety rating due to its rock-solid Dividend Cushion ratio of 3.4. Please note these forward-looking indicators factor in double-digit per share payout growth over the coming fiscal years. We give Nike an “EXCELLENT” Dividend Growth rating as well.
Back in fiscal 2018, Nike planned to grow its digital sales to about 30% of its total revenues by fiscal 2023. Now management aims to grow Nike’s digital sales to about 50% of the firm’s total revenues by fiscal 2023 as Nike’s digital strategy is playing out better than expected.
With that in mind, shares of NKE appear fully valued as of this writing as the market appears to have already priced in a sharp rebound in the retailer’s financial performance over the coming fiscal quarters. The growing headwinds posed by a second wave of COVID-19 infections needs to be kept in mind as it relates to potential downside risks.
—–
Luxury Goods (Established Brands Industry) – EL LULU NKE PVH REV SIG UA UAA VFC
Related: IYK, XLY, ADDYY, ADDDF, PMMAF, FL, VSTO, SPWH, DKS, AEO, ANF, VFC, COLM
—–
Valuentum members have access to our 16-page stock reports, Valuentum Buying Index ratings, Dividend Cushion ratios, fair value estimates and ranges, dividend reports and more. Not a member? Subscribe today. The first 14 days are free.
Callum Turcan does not own shares in any of the securities mentioned above. Both the Best Ideas Newsletter and Dividend Growth Newsletter portfolios include a SPDR S&P 500 ETF Trust (SPY) put option holding with a $295 per share strike price that expire on August 21, 2020. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.