Nike's Growth on Track

Nike’s NKE fiscal 2019 fourth-quarter sales of $10.18 billion slightly exceeded our $10.16 billion forecast. North America sales growth of 7.5% beat our 3.5% forecast as sales of basketball shoes and innovative products like VaporMax were strong. The company reported double-digit growth with important U.S. partners despite recent weak overall sales reports by Foot Locker, Nordstrom, and other U.S. apparel retailers. In greater China, Nike’s sales growth of 15.6% (22% currency-neutral) beat our estimate of 13.0%. We believe the company is on track to achieve our midteens long-term annual growth expectation for the region. Fourth-quarter earnings per share of $0.62 came in just below our $0.63 forecast due to a difference in share count and a higher tax rate. We believe that Nike’s intangible brand asset provides a wide economic moat and that the company continues to execute well on its strategies, including direct-to-consumer sales, product innovation, and supply chain improvements. We view Nike’s digital business (35% growth in fiscal 2019) to be key, as it allows the company to control marketing and improve pricing while reducing dependence on physical retailers.

Nike expects sales growth in the high single digits (excluding currency) in fiscal 2020, in line with our forecast. We think currency headwinds may reduce Nike’s fiscal 2020 first-quarter gross margin by 50-70 basis points. Despite this impact and investments in RFID inventory tracking, Nike’s guidance is for nearly 50 basis points in gross margin improvement and slight leverage in sales, general, and administrative expenses in fiscal 2020. We believe these improvements are achievable as digital sales increase and supply chain efficiencies are realized. Nike’s fiscal 2020 guidance matches our forecast of 40- and 60-basis point improvements in gross and operating margins, respectively, so we do not expect to change our $98 fair value estimate. We continue to view the shares as undervalued.

The ongoing trade dispute between the United States and China does not affect our near-term outlook for Nike. While expanded tariffs on U.S. imports from China would bring higher costs for many apparel and footwear companies, we think the effect on Nike would be immaterial. Although about one fourth of Nike’s merchandise is manufactured in China, only a small amount of it is imported to the U.S. A large amount of Nike’s Chinese-made merchandise is now sold in China. Its sales in greater China increased by more than $1 billion in fiscal 2019 (to $6.2 billion from $5.1 billion) and constituted 21% of its total sales. We believe Nike can avoid any new tariffs by importing merchandise to the U.S. from countries likes Vietnam and Thailand. The company has shifted production out of China in recent years for cost and efficiency reasons. Further, we do not think Nike will suffer any negative impact from possible anti-American sentiment in China. We believe Nike has been taking share from native Chinese athletic apparel companies. Over the long term, we think the greatest risk for Nike is that a lengthy trade war causes an economic slowdown in either the U.S. or China.

Competitive Edge Hasn't Wavered We view Nike as the leader in athletic apparel. Our wide moat rating is based on Nike's intangible brand asset, as we believe the company will maintain premium pricing and generate economic profits for at least 20 years. Nike is the largest athletic footwear brand in all major categories and all major markets, dominating categories like running ($5 billion in annual sales) and basketball ($4 billion in annual sales) with well-known brands like Jordan, Air, and Pegasus. Nike faces significant competition, but we believe it has proved over a long period that it can maintain market share and pricing.

We think Nike’s strategies allow it to maintain its leadership position. In mid-2017, Nike announced a consumer-focused realignment. It is investing in its direct-to-consumer network while reducing the number of retail partners that carry its product. The company is reducing its exposure to mediocre, undifferentiated retailers while increasing distribution through a small number of retailers--like Nordstrom, Dick’s Sporting Goods, and Foot Locker--that bring the Nike brand closer to consumers. At Nordstrom, for example, Nike operates its own shops with its own salespeople, allowing it to control the brand message. Nike’s consumer plan is led by its Triple Double strategy to double innovation, speed, and direct connections to consumers. Triple Double includes cutting product creation times in half, increasing membership in Nike’s mobile apps, and improving the selection of key franchises while reducing the number of styles by 25%. We think these strategies will allow Nike to hold share and pricing.

We believe Nike has a great opportunity for growth in China and other emerging markets. It has experienced double-digit growth in each of the last five fiscal years in China, and we expect it will continue to do so for at least the next 10 years. Nike should benefit from heavy investment in sports by the Chinese government. Moreover, with worldwide distribution and more than $3 billion in fiscal 2019 digital sales, Nike should benefit as more people in China, India, Latin America, and other emerging countries move into the middle class and gain broadband access.