Nike Inc. (NYSE:NKE) is engaged in the design, development, and worldwide marketing and selling of athletic footwear, apparel, equipment, accessories and services. Nike sportswear, running, basketball, football and kids shoes are its top-selling footwear categories. The U.S. is the primary and its strongest market with more than 300 retail stores and the segment generated approximately 45% of total revenues for fiscal year 2013. The future ordering program works perfectly and delivers significant success. Nike makes substantial use of this program and it allows retailers to order five to six months in advance of delivery with the commitment of timely delivery at a fixed price. In fiscal year 2013, 87% of U.S. wholesale footwear shipments and 67% of U.S. wholesale apparel shipments were made under this program.
The international markets have an extensive network of more than 450 retail stores and generated approximately 55% of total revenues for fiscal year 2013. Similar to the U.S. market Nike operates a future ordering program in Canada, Asia, some Latin American regions and Europe.
Positive Performance in the Third Quarter Reflects Strong Growth
Nike ended its third quarter of 2014 with a good performance and strong results. The company successfully generated $7 billion in revenues with double-digit growth of 13%. The robust demand for the company's brands and significant growth in its main categories were the drivers of the overall earnings increase. Converse's strong performance in the direct distribution markets of the U.S., China and the U.K. delivered tremendous growth of 16% while revenues reached $420 million. The company's strong performance was underscored by high growth in North America and Europe. High demand in running, basketball and football categories continue to fuel growth momentum for Nike. Currently Nike holds around 14.6% of the global sporting goods market, ahead of Adidas's (OTCQX:ADDYY) 11.4% share. Apart from that, Nike outperformed Adidas in the European market. In Western Europe revenues increased by 22% whereas in Central and Eastern Europe revenues increased by 17%.
The gross profits increased by 13% to $3,103 million and were backed by gross margins improving by 30 basis points and reaching 44.5% in the third quarter. Gross margins benefited from higher average price and continued growth in the higher margin direct to consumer business. However, it was partially offset by higher product input costs. In the fourth quarter, Nike expects a 25 basis point improvement in its gross margins due to the continued benefit from the product mix shift and pricing strategy despite headwinds from currency, raw materials and rising labor costs.
The demand creation expenses were $733 million and increased by 18% primarily driven by marketing support for key product launches and the upcoming World Cup. Operating overhead expense increased 15% to $1.4 billion due to investments in infrastructure, digital innovations and higher direct to consumer costs driven by comparable store sales growth and new store openings.
The substantial increase in expenses pressed net income, however the growth remained positive. Net income of $685 million grew by 3% and diluted earnings per share of $0.76 improved by 4% compared to the same quarter of the previous year.
As of the end of the quarter, worldwide future orders for Nike's athletic footwear and apparel totaled $10.9 billion, reflecting an increase of 12% compared to the same period of the previous year.
China issues continue with little improvement
The sportswear market in China has seen lot of growth and over the last seven years, the market has grown at a CAGR of around 30%. This potential is driven by the booming economy and improving disposable income. However, Nike's performance in Greater China remained poor for five consecutive quarters and improved by 4% in the second quarter and 7% in the third quarter of 2014. The growth was led by continuous efforts to increase the productivity and profitability of retail spaces and expansion in the sportswear, running and basketball segments. Poor sales volume resulted in higher inventory levels. This urged the company to offer heavy discounts to clear the inventory and this adversely affected top-line growth. However, there is still a lot of room for Nike and the strategy would be helpful to gain momentum in this lucrative market. The China athletic apparel market could grow at a CAGR of 17.2% from 2013-2017 thus reaching $32 billion by 2017 due to escalating consumer interest in health and fitness activities, leading to an increase in the number of sports and recreational facilities and fitness gyms in the country.
World Cup 2014
Nike is making an aggressive push into the football (soccer) market and the company expects that it could soon earn more from soccer than basketball. For the next few years, Nike's focus will be the Brazilian market as the nation will host the 2014 FIFA World Cup and the 2016 Summer Olympics.
Recently Nike has introduced Magista, a brand-new model designed especially for participants in the 2014 World Cup. Nike sponsors Argentine star Lionel Messi and his Barcelona clubmate Andres Iniesta will showcase the company's new boots at the World Cup. Nike used its Flyknit technology and will be able to charge premium prices for the boot. This is the perfect time to launch the product due to the World Cup and increased demand this season will help boost revenues for the coming quarters. Nike also will supply the kit for more teams than Adidas for the first time ever at this year's World Cup finals. It will be providing the kits for 10 teams at this year's World Cup finals including Australia, Brazil, Croatia, England, France, Greece, Netherlands, Portugal, South Korea and the United States. Nike had a 12.1% share of the Brazilian market in 2013 compared to Adidas's 5.5% share. Nike's sponsorship of the host country's national football team alone gives it a massive competitive edge. Brazil's general sportswear market will grow by $1.4 billion or 12.5% in 2014. This is the best opportunity for Nike to capture more market share.
For the current fiscal year, Nike expects its revenue to grow by high single-digits and also expects a gross margin increase of 90 basis points. The company is planning for fiscal year 2015, it expects to see continued strong momentum in 2015 and the summer Olympics will fuel the growth in 2016. Recently, Nike launched an array of innovative footwear and apparel for the NFL. The company also launched vapor carbon cleat footwear using its 3D printing capabilities and will be able to charge premium prices for its innovative products. In the apparel segment, it emerged with a collection of training and sportswear products designed to be lightweight. Nike's portfolio includes a diverse set of categories and the company is well positioned to add more growth. Nike is trading at a forward P/E of 21.14X which may seem a bit expensive but keeping in mind the strong growth potential this multiple is justified and I give this stock a long-term buy rating.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.