After announcing less-than-desirable earnings, Nike Inc. (NYSE:NKE) saw its sharpest one-day plunge in the past four years last Friday. The company was already in the middle of a downward trend that started in May as the stock price moved from $110s to $90s per share, and the stock price moved all the way down to $86 per share on Friday. The stock price is now off from its May high by 34% and many people rate it as buy. While I agree that Nike is a "buy" and it has upside, I don't see it going above $100 per share for a while.
The company's quarterly profit was 7.6% lower this year compared to the same period last year. The slowing global economy and the high marketing costs played a role in this decline. Additionally, the declining margins were to blame as well. The company needs to find a way to reverse the decline in its gross margins, now spanning six quarters in a row, in order to see profit growth in the short term.
One major pressure on Nike's margins was high material, fuel and transportation costs, doubled with high tax rates (i.e., while the company's income before taxes grew at a rate of 5%, its tax payment grew at a rate of 7% in the last year). At the moment, fuel and material costs are getting more under control; however, the sharp fluctuations in commodity prices will continue to be an issue for years to come. Also, fluctuations in currency exchange rates play a strong role in actual income figures of the company.
The company attempted to increase its prices in order to make up for the increased investment, production and marketing costs; however this was not enough. In the last year, the company's inventory grew at a much faster rate than its sales growth rate. The company currently has a bulky inventory that needs to shrink, and this will require some price reductions. The inventory will be difficult to shrink unless the European economy starts a fast recovery mode, which I don't see happening anytime soon.
On a positive note, the company's revenues continued to climb at a double-digit rate. Nike's quarterly revenue of $6.5 billion in the last quarter is an all-time high for the company. Nike was able to sell 10%-12% more products in the last quarter compared to the same quarter a year ago. For the year, the company posted a revenue growth of 16%. Annually, the company's earnings grew at a rate of 4%. This is not a very high rate, however, it is still impressive given the slowing global economy and high commodity costs in the last year. With the exception of Europe, the sales growth rate was nearing 20% in most geographical regions. Of course, this sales growth came at a cost, as the company's marketing costs surged by 23% compared to last year.
Nike will be getting rid of its loss generating brands, Cole Haan and Umbro. In the later quarters, this should increase the company's margins as it will increase its focus on the more profitable brands. I would argue that as Nike enjoys a strong brand name not many companies enjoy in the world, it shouldn't have to spend so much money for marketing for much longer. Over the years, the company has spent a tremendous amount of money to build its brand name, and Nike is now a well-known name all over the world. I doubt there is any geographical location in the world where Nike isn't regarded as a strong and prestigious brand name. This year's European Soccer Championship and Olympic Games will strengthen the company's brand image even further.
Nike's CEO Mark Parker expects both a "great opportunity" and "persistent challenges in" the next fiscal year. Definitely uncertainty will dominate the next few quarters for the company as it will attempt to convert the challenges into opportunities. Nike is one of the few western companies that have a very strong presence in China, and the company was always expected to see strong growth in the country.
The company acknowledged that both competition and consumers are getting more sophisticated in China. This is probably why the company continues to spend large amount of money on marketing efforts, despite the strong brand name enjoyed by the company. I still think Nike can and will bring its high marketing costs under control in the long term.
On a side note, I find the analyst reaction interesting in Nike's case. For example, analysts working for Sterne Agee downgraded the stock from "buy" to "neutral" due to the weaknesses in China, yet the same analysts set a 12-month price target of $125 for the stock, indicating a potential upside of 45%.
In conclusion, Nike is a strong brand name with a lot to offer. The company is a great investment, given its management, growth prospects, brand portfolio and strong image. However, in the short term, the company has a lot of issues to deal with and many of those issues are not exactly those that can be fixed from the inside (e.g., weakness in the global economy).
I believe that Nike is a "buy," but the company's upside potential will be limited until some of the issues faced by it are overcome. For long-term investors wanting to initiate a long position in Nike, this is the perfect time, but you will have to be patient and wait at least a couple years to see great returns.
Disclosure: I am long NKE.