WASHINGTON: Nike Inc’s shares surged to a two-year high on Friday after two Wall Street brokerages said the footwear maker’s profitability would soon reap the benefits of its recent move to sell directly to consumers.

Nike’s shares jumped nearly 5 per cent, set for their best day since June 30, 2017, when the company said it would sell more products directly through retailers such as Amazon.com Inc and its own stores, rather than through wholesalers.

Bernstein Research and Wedbush Securities said this direct-to-consumer (DTC) model would boost Nike’s margins once the plans were fully implemented and the business accounted for a larger chunk of total sales from the current 28 per cent. In fact, Wedbush estimated Nike’s overall gross margins would expand for the first time in 10 quarters in the March-May quarter. It upgraded Nike’s stock to “outperform.”

Analyst Christopher Svezia said the company’s results next fiscal would also get a boost from the launch of new shoe styles and easier comparison with last year, when it took a bit of a beating from weak demand in North America.

Bernstein estimated said Nike’s realized retail price was double its wholesale price, suggesting the gross profit contribution of each product it sold directly was more than three times higher than if sold through a wholesaler. “As Nike moves from a wholesale business to a more direct business, we believe there is clear margin upside from this shift,” analyst Jamie Merriman wrote in a note.

Merriman estimated gross margins in Nike’s DTC business are 62 per cent, compared with 38 per cent in its wholesale business.

Nike’s overall gross margins could grow by as much as 3.3 percentage points by 2022, Merriman estimated, if the DTC business increased to about 42 per cent of total revenue.

That growth would be even more if margins in its e-commerce business scale to those in its store business, Merriman said, who rates Nike’s stock “outperform.” The company’s shares were up 4.5 per cent at $66.98, easily the top gainer on the bluechip Dow Jones Industrial Average. The stock rose to as much as $67.14, its highest since December 2015.

Increase sales

Nike is showing more and more signs that market saturation is undermining their ability to increase sales. I’m referring primarily to the North American market, where Nike is dependent on cash flow and financial stability. The first fiscal quarter of the year displayed a weakening ability for the juggernaut to maintain US sales figures. 2018 started with basically flat revenues of a little over $9 billion. Now the second fiscal quarter has begun to show a trend for flatline growth.

For a company of Nike’s size, it does become difficult to deliver a large percentage rate increases in sales. For second quarter ‘18, Nike put up a 5 per cent increase in revenues. That would be OK, if the company hadn’t increased cost of sales by 7 per cent to obtain it. Gross profit margins declined to 43 per cent from 44.3 per cent, while net income for the quarter declined 9 per cent year over year to $767 million.

For the six months ended November 30th, Nike’s total revenue grew 2 per cent year-over-year to $17.62 billion.

Cost of sales have increased 5 per cent to $$9.98 billion, drawing down gross profits by 1 per cent to $7.64 billion. It’s a troubling trend when it’s costing Nike more money to produce growth than it used to. Demand creation expense (what a term) is down for the fiscal year, but went up 15 per cent in the second quarter to $877 million. When you factor in the expanding overhead expenses of $1.89 billion, total selling and administrative expenses were up nearly 2 per cent as a percentage of revenue (32.4 per cent) in the quarter. So why does all this matter? It matters because net income for Nike is shrinking as they spend more and more cash in order to drum up new demand for their goods.

Agencies