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Japanese baseball players will not wear the number four jersey because the number, pronounced shi, also means death.
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Nike: Problem of Plenty?
Nike Inc.’s (NKE) shares fell to their lowest since April 2020 after their biggest single-day drop in two decades. From a time when it did not have enough inventory to cater to demand, it now has too much of it. A stronger dollar doesn’t help. Will these loose laces mean investors end up tripping?
Sneaking Troubles
Nike’s problem of plenty differs from the usual positive connotation. For the footwear giant, the problem of plenty has only resulted in headaches for the management and its shareholders.
The economic cycle of the last two years can make heads turn (not in a good way). At a time when pent-up demand from the pandemic shot through the roof, no company could manage to get enough inventory due to a crippled supply chain. Anticipating that the demand would remain robust and supply-chain would remain crippled, companies ordered more and before-time inventory to be prepared to meet demand.
Cut to the present, as inflation breaks the consumer’s back, demand has seen a dramatic slump, and all the pre-ordered stock now lies in cold storage. Nike, in particular, has failed to resolve its logistics issues due to port congestions and shipping logjams. Other headwinds include Covid-related store disruptions in important markets like China.
Over the last two years, Nike has also pivoted its strategy by trying to sell merchandise directly to customers and online instead of wholesale partners like Foot Locker. For the quarter that ended August, direct and online sales outperformed the wholesale division.
The rising cost of living has also taken a toll on “sneakerheads,” who now think twice before spending on every new product launched. Nike’s hot-selling “Jordan,” which would usually sell out within minutes, is also experiencing a downturn in enthusiasm and demand.
Analysts believe that this slower sell-through rate for “Jordan” is unusual and confirms the signs of inflation pressure on sneakerheads. Another possibility for the slowing demand is them experiencing “launch fatigue.”
Shoe Bite!
Nike beat street estimates in Q1 FY23 despite multiple headwinds. However, one must note that analysts have been downgrading earnings estimates for the company much before the results. Analysts have cut Nike’s full-year revenue forecast to sub-$50B from ~$55B earlier.
Key Highlights From Q1 FY23:
Revenue: $12.7B Vs $12.27B expected
Earnings Per Share: $0.93 Vs $0.92 expected
The company reported a 44% jump in inventory to ~$10B on its balance sheet. Inventory in North America, its biggest market, increased 65% from last year, reflecting a combination of late deliveries and new holiday orders arriving earlier than anticipated. Inventories in transit are also up 85% year-on-year.
As a result, Nike now has an inventory for a few seasons available at the same time. As a result, it will now take aggressive steps to liquidate the inventory to put the best ones out at the right locations.
Also hurting the company's results is a stronger US Dollar, which crushed Gross Margins by 220 basis points in Q1 to 44.3%, lower than estimates of 45.4%. More than half of Nike's sales come from outside North America. It has now doubled the forex headwind on its full-year sales to $4B.
For FY23, gross margins are likely to fall 200-250 basis points from the earlier forecast of gross margins being flat or declining as much as 50 basis points. The management expects a steeper erosion in margins in the current quarter. The stronger greenback also means full-year sales growth will now be in the low to mid-single digits, whereas stripped for currency, they may rise in low double-digits.
China is Nike's third-largest market by revenue. Almost 30% of Nike's footwear and 20% of apparel is manufactured there. The country's Covid-zero policy has resulted in sales dropping for the fourth quarter in a row. The management had mentioned in the previous quarter that issues in China would weigh on the company's business.
However, despite the volatility in demand, the company sees China as a long-term growth market and will continue investing there. CEO John Donahoe says Chinese customers are emerging from the Covid restrictions with a willingness to spend and that trends in the country will improve soon. He also noted that demand in North America remains robust despite the inflation headwinds.
Analysts expect substantial markdowns from Nike through the holiday season. They pin their hopes and estimates on the consumer environment and how willing they are to spend. However, they expect inventory levels to go down in the calendar year 2023 but expect intense margin pressure due to excess inventories. Analysts even want Nike to have an “excess clearance activity” to clean up the marketplace.
Shares of Nike have halved this year and are among the worst performers on the Dow Jones. Nike sneezing has also meant the entire group has caught a cold. Of course, customers will not stop wearing footwear, but this time around, the footwear, as well as the stock, are leaving investors and customers with nothing but shoe bite!
Market Reaction
NKE ended at $83.12, down -12.81%.
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