RealMoney Silver - NKE Outruns the Street

NKE Outruns the Street
By Ron Thomas
RealMoney Contributor
12/20/2007 9:46 AM EST

Updated from 1:11 p.m. EST on Dec. 18.

Nike (NKE) handily beat Street expectations, reporting EPS of 71 cents vs. an anticipated 66 cents and 64 cents last year, which was an 11% gain. Revenue was slightly above expectations at $4.3 billion vs. $4.2 billion, a 14 % increase. After 4 points of currency, real sales were up a commendable 10%.

Gross income rose 16%, as the gross margin increased 0.9%, to 44.3%. SG&A was up 17%, from 30% of sales to 32.9% of sales. Demand creation was $557 million in the quarter, up 12%, to12.8% of sales. Other overhead rose 14%, equal to sales. So, pretax income rose 15%, to 15% of sales. A 3% higher tax rate, at 30%, took the net income increase down to 10%.

U.S. revenue increased 7%, accelerating from the 3% comp of the first quarter. Sales at company-owned stores rose 17% and 6% through other retailers. Pretax income rose 9%.

Athletic footwear increased 12%, bucking the very weak consumer buying trend. Apparel sales, however, were down 3%, though that is better, I would expect, than apparel trends overall.

Most weakness was in more moderately priced sports culture apparel, about what would be expected in this environment. One note of caution on athletic footwear is that average pricing was down and mix was better, which implies some fashion (athletic fashion, which I believe is toward basketball) issues are temporarily masking some consumer weakness.

EMEA revenue was up 18%, 8% currency adjusted. Footwear was up 15%, and apparel rose 10%, both currency adjusted. Western Europe is showing more strength, and Russia and Turkey are strong. Pretax income rose 37%.

Asia/Pacific revenue grew 17%, 12% currency adjusted. Footwear and apparel had real revenue increases of 15% and 10% respectively. Pretax income rose 19%.

Latin American results were strong.

Inventory is only up 3%. Futures orders were up 10% real, 13% pre-currency adjustment. The U.S. increase was 1%, and real increases were EMEA by 13%, Asia/Pacific by 20% and Americas by 17%.

Japan had revenue and futures increases, with a decline in inventories. Management is optimistic. China is adding 500 to 600 doors per year and should increase at that rate for the next two years.

U.S. futures are becoming more delinked from sales expectations as apparel gets bigger, and a larger amount of sales will come from Nike's own stores. Seeing some expected sales weakness in the U.S., management said that mid-single-digit revenue growth is the expectation for this fiscal year.

Management wants better positioning in sports culture-related apparel and footwear and believes that initiatives in this areas will take hold in late summer to early fall. A lower-positioned Converse brand is being introduced to Target (TGT) in February.

Currencies are hedged 12 to 18 months in advance. Promotional money is being shifted out of advertising to the retail level for experiential promotions, etc.

Some surgical price increases are being taken, and management is confident that the company will be able to manage the gross margin from here -- even with higher input costs. (Nike certainly seems to have done a masterful job, or I did not really realize how much waste and slack there was in its system from years past.). Management did add that it manages for operating margin mostly.

The quarter was just great. While it makes no sense to me to bet against the weight of the biggest U.S. consumer slowdown that I will likely ever see in my career, the international strength looks likely to take Nike through the Summer Olympics in China without any earnings hiccups. If I had the time, I might even reexamine the Street's 13% five-year growth expectation, which might be a bit low.

NKE Preview: How Long Will This One Run?

Nike (NKE) stock has been a stellar performer, as the shares have risen 34% in the last year and have been up strongly in the past quarter as well. That has been in marked contrast to other consumer-oriented stocks, which are more dependent on American sales than Nike, which gets 57% of its sales overseas.

The average Street EPS estimate calls for EPS of 66 cents, up 3% from the 64 cents of last year, accompanied by a 10.2% sales increase, to $4.21 billion. I am thinking that the February quarter's 79-cent estimate, up 14% from 69 cents last year on a 10% sales increase, could be cut at the conclusion of the call.

I am moderately puzzled that, even with 57% of sales coming from overseas, the lowest EPS estimates for fiscal 2008 and 2009 are $3.52 and $3.74, respectively, only slightly below the $3.56 and $3.86 average. So the present price discounts an 11% five-year growth rate using consensus EPS estimates, and the lowest estimates imply 12%. Neither are enough below the probably somewhat optimistic 13.5% sell-side average to justify a buy at this point.

The questions from which to glean information on the EPS result and the conference call are as follows:

Will incremental U.S. sales or margin weakness put pressure on nearer-term earnings?
Will international sales increases stay strong as these economies possibly miss the effects of an economic slowdown here?

In the U.S., the Christmas-related news this morning is of extremely poor apparel sales. OK, I know that Nike is probably close to the top of the apparel food chain, but electronics are the hot category this Christmas, and some of the biggest purchasers of new electronics items are contributors to Nike's industry-leading gross margins.

Thinking about gross margins, I have been wrong in thinking that Nike would have pressure on its gross margins over the last year or so. The American consumer has held up longer than I expected, and, at a valuation close to fair value, it is a bigger risk now to believe that margins will come through relatively unscathed.

While it more than likely has no investment significance over the next year, I have to wonder if the baseball steroid report could undermine the aura of technical or sports-culture-related shoes as some people get turned off by professional athletics in general. I would watch for any developments in this area.

First-quarter U.S. sales were only up 2.3% with the average price down mid-single digits. Analysts were willing to accept that this was a shift away from higher-priced basketball shoes, with the implication that there is more fashion involved than price elasticity. With Nike apparel and equipment sales both down 1%, I lean toward price elasticity. It goes without saying that U.S. sales and mix will be the biggest near-term swing factor in EPS.

Internationally, the percentage growth in futures, which have accelerated nicely over the past three quarters, will be closely watched. My guess is that the strong international regions' revenue growth rates will be slowing a bit but will still be strong.