Q1 Performance Shows Nike Has Got Its Mojo Back

Investment Thesis

Last time I analysed NIKE, Inc. (NYSE:NKE), I discussed how the tide was slowly turning for the company thanks to a remarkable uptick seen in China and a significant improvement in the company’s inventory levels.

In this article, I talk about the key highlights of the company’s first quarter performance. More specifically, I mention how the company has firmly gained its mojo in China and how the initial foundation laid out by the company ahead of the Paris Olympics could become a strong catalyst for growth.

A Snapshot of Nike’s First Quarter

The company had a rather subdued first quarter. Q1 revenues came in at $12.94 billion, which although were up 2% year-over-year, missed estimates by $62 million. Diluted EPS came in at $0.94, beating estimates by $0.18. The company continues to see pressure on its gross margins due to the moves made to manage its inventory levels. While inventory levels were down 10% year-over-year, the company also saw its Q1 gross margins dropped 10 bps to 44.2%.

Despite the negatives, management offered strong guidance with Q2 revenues expected to be up year-over-year and Q2 gross margins set to expand by approximately 100 bps, as a result of improved markdowns and lower ocean freight. For the full year, the company maintained its previous guidance of revenues growing at mid-single digits and gross margins expanding by 140 to 160 bps.

Nike’s Performance in China Continues to Dazzle

One of the major takeaways from Nike’s first quarter was the continued strong performance seen in the Greater China region. Q1 revenues in the region jumped 12% year-over-year with NIKE Direct growing 10% and NIKE Digital, which experienced a decline in the last quarter, seeing a rebound, jumping 6%. The only blemish on an otherwise dazzling performance was the 3% decline in EBIT.

The strong performance in China was driven by the back-to-school promotional campaigns as well as the surging demand seen for the company’s newly released Kobe brand. Furthermore, despite the environment being rather promotional in nature, the company still managed to witness full-price sell-through for its latest launches in the region. The company also saw supply chain costs stabilising in the region, a massive boost to its margins.

If the company can somehow navigate the foreign exchange headwinds in the coming quarters by capitalizing on the surge in demand for its products, especially in the basketball segment, then it could be on the cusp of getting its mojo back in the region.

Women’s Soccer World Cup Helps Nike Regain its Footing in EMEA

It is not only China that stood out for the company in the first quarter but also the EMEA region. Driven by the demand resulting from the Women’s soccer world cup, the company also saw decent growth in the EMEA region. Revenues from the footwear segment jumped 10% year-on-year, on a currency-neutral basis, as a result of strong demand for all of the company’s boot franchises (Mercurial, Phantom, Tiempo, and Phantom Luna). The company also saw strong growth from its strategic partnerships with Sports Direct in the region, which was yet another catalyst for the company’s impressive performance.

While operating margins in the region also came under pressure, the strong demand seen in the region for the company’s latest launches such as the new walking shoe Motiva and the cross-fit shoe Metcon, offers a promising future for the company in the region, especially since it is helping Nike gain ground in a new performance category.

The Buzz for Paris Olympics a Welcome Catalyst for Nike

While Nike may not benefit much, in my opinion, from the upcoming Cricket World Cup (there was no mention of the event during the company’s earnings call), the company is already getting ready to capitalize on the 2024 Paris Olympics. For instance, the company plans to launch the latest version of the Nike Air as part of the tenth anniversary of the company’s Air Max Day, and in time for the Olympics. The company also plans to launch the basketball footwear Nike Dunk Low “NBA Paris” edition early next year as part of its “Olympics collection.”

And then there is Nike’s plan to firm up its presence in the athleisure category via breakdancing, which is set to become a sport for the first time at the Paris Olympics. The company, in the quarter gone by, already started laying the foundation for this as it managed to interact with some of the elite break-dancers, on campus, who would be competing in the Olympics. The company even sponsors some of them. If breakdancing really becomes successful next year, then Nike stands to benefit a lot, especially with respect to its plans to get a grip on the athleisure category.

Valuation

Source: Refinitiv, Author’s Calculations & NKE Q1FY24 Earnings Call

Little has changed since the last time I addressed Nike's valuation, especially since the company re-affirmed its guidance for FY24 in the quarter gone by. The only change I have made in this article is that I now assume operating margins to expand by 150 bps instead of 140 bps, given that the company has boosted its margin guidance for Q2. This results in a marginal uptick in my gross margin estimate, which now comes in at 45.1%, which subsequently results in FY24 gross profits of $24.35 billion.

I have maintained the SG&A expenses and other expenses at $17.4 billion and $250 million respectively. I now estimate the effective tax rate to come in at 19% as opposed to 18.2%, given that the company expects tax rates to be in the high teens. Taken together, this results in total net income of $5.43 billion. According to Refinitiv, the total number of shares outstanding is 1.21 billion, which results in a projected EPS of $4.48.

The company currently trades at a forward P/E of 24x, which relative to its historical median values, is cheap. The 5-year historical median P/E for the company is 30x and the 10-year historical median P/E for the company is 27x. Given the challenging macroeconomic environment that the company finds itself in, I have assumed a forward P/E of 27x.

At a multiple of 27x and a projected FY24 EPS of $4.48, I get a revised price target of $121 (my earlier price target was $125), which still represents a 27% upside from current levels.

Risk Factors

The promotional environment, which I mentioned in my earlier article, continues to exist, thereby making it a significant risk factor for the company, especially since it threatens to put pressure on its margins in China. Furthermore, in the U.S., with student debt repayments set to resume, it is likely to cause a significant headwind to the company.

Finally, Nike stands out to miss out on a chunk of revenues, especially in the APAC region, given its lack of presence in the Cricket World Cup. India is the host nation of the tournament, and the fact that the company’s rival Adidas is the kit sponsor of the Indian cricket team, who are one of the favourites to win the tournament, feels like a missed opportunity for NKE. No wonder then that the tournament was not even mentioned by Nike management during the earnings call.

Concluding Thoughts

Nike had a subdued first quarter as the company posted a rare revenue miss. However, upbeat guidance from the management had a positive impact on the stock price following the earnings release. Despite the positive sentiment seen in the stock post results, the stock is still down 19% YTD, as a result of the challenging macroeconomic conditions and the promotional environment that the company currently finds itself in.

Having said that, based on the Q1 performance, it appears that the company has got a grip on two of its significant catalysts: inventory management and growth in China. Furthermore, the women’s soccer world cup also helped the company to log strong revenue in EMEA. While current conditions continue to put pressure on its margins, this appears to be more of a short-term blip than a long-term headwind. Moreover, the massive correction seen in the stock has only made it attractive, given that the long-term tailwinds continue to persist.

Whether the company can sustain its growth in China while normalizing inventory levels, by capitalizing on the demand generated by upcoming sporting events, will determine the next phase of its future growth. The ball is firmly in Nike’s court now.