Morning Note: Market news and an update from Nike.

Market News

US equity markets edged higher last night – S&P 500 (+0.1%), Nasdaq (+0.3%) – ahead of the release of the Fed’s preferred inflation gauge. The core PCE index for May is expected to slow to 2.6%, the lowest reading since March 2021. Nike fell heavily following the market close after the company lowered its guidance (see below).

This morning in Asia, markets also ended in positive territory: Nikkei 225 (+0.6%); Hang Seng (+0.4%); Shanghai Composite (+0.7%). The FTSE 100 is currently trading 0.6% higher at 8,236.

Sterling trades at $1.2647 and €1.1818. The oil price edged up to $85.76 a barrel. Gold trades at $2,327 an ounce. The yellow metal has risen more than 4% this quarter, heading for its third quarterly gain.

On the political front, Joe Biden stumbled through exchanges in the presidential debate, exacerbating concerns about his age and his ability to defeat Donald Trump. Even as he put the former president on the back foot over his felony convictions and the 6 January demonstrations, Biden’s performance was punctuated by repeated lines, misstatements, and an extended freeze. Elsewhere, UK polls point to a landslide win for Labour, though few expect a revival of the Cool Britannia optimism that greeted the party’s win in 1997. Traders are heading into this weekend’s French elections betting the country’s bond yields will continue to rise.

Source: Bloomberg

Company News

Last night, Nike released results for its financial year to end May 2024 which were slightly below market expectations at the revenue line. However, guidance for FY2025 has been lowered in what is now described as a transition year with revenue now expected to be down by a mid-single digit percentage. In response, the shares fell by 12% in after-hours trading.

Nike is the world’s leading sports footwear and apparel company. We are positive on the long-term outlook for the business, with the company well placed to benefit from increased consumer demand for healthier living – the recognition of which increased during the pandemic – and the shift to personalised products. Nike has a very strong brand, an impressive track record of product innovation, and is seeking to be more personal with its consumers at scale.

However, in the near-term, lifecycle management of key product franchises is more than offsetting the scaling of new products. In addition, revenue is being held back by the subdued economic backdrop, continued promotional activity, and increased competition from new brands such as On and Deckers’ Hoka.

In the face of these industry dynamics, the group has undertaken an enterprise initiative to accelerate future growth while building a faster, more efficient company. The aim is to deliver up to $2bn in cumulative cost savings over the next three years from simplifying the group’s product assortment, increasing automation and use of technology, streamlining the organisation, and leveraging scale to drive greater efficiency. Most of these savings will be reinvested to fuel future growth, accelerate innovation, and drive greater long-term profitability.

Management has admitted while Nike Direct (in particular digital) will continue to play a critical role, the company has neglected its wholesale partners which are essential to elevate its brand and grow the total marketplace. The company has accelerated its multi-year cycle of innovation and has pulled forward several innovations, including the Air platform (both performance and lifestyle), Running (Vomero, Structure, and Pegasus), and Women’s. At the same time, Nike is carefully managing its most important franchises for long-term health and, as a result, the product portfolio is going through a ‘period of transition’ which is expected to continue in the current financial year.

Last night, the company published its results for the financial year to 31 May 2024. Revenue grew by 1% on a currency-neutral basis to $51.4bn, in line with company guidance. In the final three months of the financial year, revenue was flat on a currency-neutral basis at $12.61bn (vs. guidance to be ‘up slightly’), and the below market estimate of €12.85bn.

Nike Brand sales were up 1% in the year to $49.3bn but down 1% in Q4. The Converse brand fell by 15% to $2.1bn in the year and by 17% in Q4.

By region, Nike Brand revenue generated currency-neutral growth in Asia Pacific & Latin America (APLA, +5%) and Greater China (+8%), offset by a 1% decline in North America and a flat result in Europe, Middle East, & Africa (EMEA) driven by increased macro volatility, softening consumer demand, elevated promotional backdrop, and slower digital activity.

Nike Brand sales are split into Direct sales (both online and through Nike-owned stores) and wholesale revenue from third party retailers. During the year, Nike Direct sales grew by 1% to $21.5bn (but down 7% in Q4), with digital down 3% and stores up 6%. The 10% decline in digital in the final quarter (a trend that has continued into the current financial year) was worse than management expectations. Wholesale grew by 2% in the year to $27.8bn, and by 8% in Q4.

Digital sales have a long-term financial benefit for the group – on average, a sale of an incremental unit via digital generates double the revenue for Nike versus a sale to wholesale, with a 10% higher gross margin, translating into two times the operating income dollars. Clearly the recent slowdown in the digital business will have an outsized impact on the group’s top line and margin.

The gross margin rose by 110 basis points in the year to 44.6%, just below the guidance for 120bps of expansion. This was primarily due to strategic pricing actions and lower ocean freight rates and logistics costs, partially offset by higher product input costs and lower margin in Nike Direct. During the last quarter, the gross margin increased by 110 basis points to 44.7%.

Selling and administrative expenses grew by 1% (down 7% in Q4), including $379m of restructuring charges, with demand creation expense (i.e., marketing) up 6%. Operating overhead expenses were flat as lower wage-related expenses and lower technology spend were offset by restructuring charges.

Full-year EPS rose by 15% to 3.73c, including 22c of restructuring charges. In Q4, EPS rose by 50% to 99c, including 2c of restructuring charges, versus the market forecast of 83c, helped in part by a lower tax rate.

Inventories continued to fall, down 11% in the year to $7.5bn, primarily driven by a decrease in units. With stock levels now down, the company can focus on pushing new innovative products through the pipeline. Cash flow from operations grew by 27% on significant improvements in working capital.

The group’s balance sheet remains very strong – with net cash of c. $2.7bn. During the final quarter, the group bought back $1.0bn of its own stock as part of its 4-year $18bn share repurchase programme, while the quarterly dividend was raised by 9% to 37c.

Looking to the financial year to May 2025, the group is ‘managing a product cycle transition, with complexity amplified by shifting channel mix dynamics’. Management admits that a ‘comeback at this scale takes time’. They expect lower Nike Digital growth due to lower traffic on fewer launches, planned declines of classic footwear franchises given Q4 trends, as well as reduced promotional activity. Macro uncertainty remains, particularly in Greater China, with uneven consumer trends in EMEA. The final factor to consider is the sell-in to wholesale partners, as Nike scales product innovation and newness across the marketplace and finalises second-half order books.

Against this backdrop, the group has lowered its guidance. Revenue is now expected to decline by a mid-single digit percentage versus the previous expectation for some growth. The decline is expected to be worse in the group’s first half (down high single digits). The current quarter is forecast to be down 10%.

Encouragingly, the gross margin is expected to expand by 10 to 30 basis points, reflecting the benefits from strategic pricing actions and lower product input costs, partially offset by supply chain deleverage, channel mix shifts, and currency impact. 

There is clearly concern over the group’s forecasting ability given the sharp reduction in revenue guidance over the space of a one quarter, leaving the market somewhat sceptical over the timing of a turnaround. However, long-term outlook for the industry remains positive – according to Euromonitor data, the global sportswear industry is forecast to grow by 6%-7% over the next five years – and the group’s strong brand and innovation track record provide further source for optimism.

Source: Bloomberg