Holding On In This Environment? Nike Is ‘Just Doing It’

Nike (NKE) recently reported second quarter earnings per share of $0.80, up 13% from last year and two cents above the consensus estimate of $0.78 per share. Although some of this growth was due to currency gains and a lower tax rate, Nike is still doing arguably well in an extremely tough macroeconomic environment.  Nike is a large, geographically diverse company, so in order to get a real feel for how the Swoosh is doing, we need to break down the results.  Nike categorizes their units into U.S., EMEA (Europe, Middle East and Africa), Asia-Pacific, Americas, and Other Businesses. Let’s take a look.

U.S.  (32.8% of revenue)

Nike’s domestic business, which accounts for approximately one third of the company’s overall revenue, showed the most weakness, which was to be expected. Sales were down 1% to $1.51 billion, as the American consumer pulled back on discretionary spending.

U.S. footwear, which generated a little under $1 billion during the quarter, managed to pull off 1% growth. Nike and Jordan footwear have gained 300 basis points of market share over the past 12 months, showing Nike has really been able to leverage its brand names during the recessionary environment.

Apparel did not manage to do as well, showing a 3% drop in revenue, to $450 million. Weakness in sportswear was partially offset by growth in running and team apparel. U.S. apparel also managed to gain market share over the past 12 months, but not enough to overcome the overall slump in the sector.

Equipment, which represented $70 million in revenue, saw a 17% drop.

Revenue at Nike-owned retail stores grew 1%, due to growth in e-commerce and new store openings. Comparable sales for these company-owned stores fell 20%, however, due to relatively lower promotional activity and the stores’ locations in high tourist areas.

US pretax income fell 18% to $253 million, due to lower gross margins and higher selling, general and administrative expenses (SG&A).  This was mostly due to the Nike-owned retail expansion.

EMEA (28.3% of revenue)

In the Europe, Middle East and Africa, Nike displayed signs of promise as well as signs of worry. Revenue grew 6% to $1.3 billion, although 2% of that growth is attributed to currency effects. Emerging economies within EMEA showed very strong growth, and carried the segment. Southern Europe is a concern, as the region saw declining revenues.

Overall, pretax income rose 19%, reflecting revenue growth, higher gross margins and stronger EMEA currencies.

Asia-Pacific (17.9%)

In the Asia-Pacific region, which many analysts and investors consider Nike’s most promising segment, revenue grew 22% to $821.4 million. 5% of the growth was due to currency effects. Even with neutral currencies, however, the region saw double-digit growth in every product type.

China proved to be the strongest country, with revenue growth of 27%, and future orders growth of 25%. Nike management considered China to be a major growth engine for the company. Japan also did well from a industrialized nation standpoint. Revenue grew 7% on a currency neutral basis.

Pretax income for the Asia-Pacific region was up 25% due to very strong sales and gross margins, as well as currency effects.

Americas (8.4% of revenue)

In the Americas, Nike grew revenues by 21% to $384.6 million. This included a 2% revenue loss due to weaker currencies of the countries within the region. On a currency neutral basis, Americas saw double-digit growth in all products and countries.

Pretax income was up 34% due to lower SG&A combined with strong revenue growth.

Other Businesses (12.3% of revenue)

Nike’s other businesses, which includes Cole Haan, Converse, Hurley, Nike Golf and Umbro, pulled in $564.5 million, down 4% from last year.

Pretax income was down 71%, due to the sale of Starter and Bauer Hockey, and the purchase of Umbro. When we only look at continuing operations, revenue grew 3%, and pretax income fell 51%, mostly due to gross margin declines in Nike Golf and Cole Haan. The company attributes this to the weak retail environment, while increased spending on demand creation initiatives for Converse also hurt margins.

Looking Forward

Ultimately, we want to know what Nike is doing to ensure it thrives during the global slowdown.  The company expects low to mid-single-digit revenue growth over the rest of the fiscal year on a currency neutral basis. Looking at futures orders and current exchange rates, we know reported revenue will most likely be less.

In terms of costs, the company plans to focus on reducing SG&A. Management stated in the earnings call that they are implementing a hiring freeze, as well as company wide reductions in travel and meetings. They are also making “surgical reductions” in other operating expenses and demand creation initiatives. As a result, third quarter SG&A will grow slightly, followed by a double-digit decline in the fourth quarter. The net effect for the second half of the fiscal year should be flat to falling SG&A.

Management is showing they are very aware of the need to be constantly acting to maintain strong performance in this environment.  Although the numbers in certain areas such as the U.S. may seem discouraging, Nike is being very opportunistic.  They are scooping up market share in various products and regions, while cutting costs and maintaining an extremely strong balance sheet.  The company continued buying large amounts of its common stock back during the quarter, and even announced a 9% dividend increase last month.  This is at least one company that won’t be asking for a bailout.

As long as management can accurately predict demand and manage inventory levels through these volatile times, earnings should remain strong.  Currency fluctuations are a concern, but Nike actively engages in currency hedges, so the effects of the strengthening dollar should be muted.  Overall, it was a rough quarter for retail, and it will only continue to get worse.  Nike, however, seems to be at the top of their game.

Disclosure: The mutual fund the author manages is long NKE.

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