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Nike (NKE) Gets Tripped Up by Rising Costs and Shrinking Margins

By: , dated July 2nd, 2012

Shares of footwear giant Nike (NKE: Charts, News) plunged last week after the retailer posted weaker than expected fourth quarter earnings. Nike reported earnings of $1.17 per share on revenue of $6.5 billion. Analysts had expected Nike to earn $1.37 per share. EPS fell 7.6% while revenue grew 12% from the prior year quarter. Excluding foreign currency fluctuations, revenue rose 14%. A strong top line failed to appease nervous investors, who forced the stock to give up all its gains over the past twelve months. Nike’s stock performance now notably trails its stronger, younger athletic wear competitors, such as Under Armour (UA: Charts, News), Lululemon (LULU: Charts, News) and Foot Locker FL (FL: Charts, News).

 

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Nike attributed its weak bottom line to higher than expected costs and shrinking margins. During the fourth quarter, Nike posted a $24 million restructuring charge from its operations in Western Europe. Nike’s “demand creation expenses”, also known as marketing costs, increased by 23% to $760 million, as it took aim at the European Football Championships and the Summer Olympics in London. Higher investments in its e-commerce segment also increased marketing costs. These higher expenses cut Nike’s gross margin from 44.3% to 42.8%.

On the bright side, Nike successfully raised prices and took advantage of lower air freight costs this quarter, but these benefits could not offset its expenditures. Worldwide future orders rose 7%, hinting at relief in the next quarter, but inventories – a key health metric for retailers – surged 23%, signaling that Nike’s supply is currently outweighing market demand. Although rising promotional costs were expected, Nike’s reported expenses surprised many analysts. Morningstar analyst Paul Swinand elaborated, “While we had expected some gross margins decline and some increase in spending with the Olympics and soccer championships, both are higher than expected.”

Analysts believe that Nike’s new products, such as its Flyknit running shoes, Nike+ FuelBand movement tracking wristbands, and sporting event branded apparel, will help draw in new customers throughout fiscal 2013. New features such as Lunar shoe cushioning should also boost sales.

Footwear and apparel sales grew by 12% and 10%, respectively, while its smaller equipment unit reported a 20% gain in sales. Nike also remains strong in China, which posted an 18% increase in sales, and other key emerging markets.

All of its main global segments posted double-digit revenue growth, with Western Europe being the company’s sole weakness, due to the ongoing Eurozone debt crisis. However, Western Europe still eked out a 2% top line gain. Although Nike has kept its head above water in Europe, its primary rival Adidas AG posted a 7% sales gain in the region.

Last month, Nike announced that it would divest from its Cole Haan and Umbro brands, in order to focus more on its core brands – Nike, Jordan, Converse and Hurley. Cole Haan and Umbro brought in $797 million in sales during fiscal 2012, with a combined loss of $43 million.

Nike is considered a cyclical stock, whose cycle generally spans over three to five years. Analysts believe that Nike is still in the middle of this strong athletic footwear cycle and may have significant upside before it loses momentum. CEO Mark Parker remained upbeat regarding the company’s products, stating that Nike is a resilient company that has withstood many trials and tribulations from economic headwinds in the past.

Shares of Nike trade at 13.4 times forward earnings, with a 5-year PEG ratio of 1.3, which both suggest that the stock is fundamentally undervalued. In addition, the stock pays a quarterly dividend of 36 cents per share – a 1.6% yield at current prices.

Other News About Nike
Nike Profit Falls on Weaker Margins, Higher Costs
Nike disappoints investors with lackluster earnings.
Nike Profit Hit By Costs, Shares Fall
Shares recover slightly from a precipitous 10% plunge.

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Leo Sun Leo Sun is a freelance finance writer and position trader. He focuses on a combination of value and momentum investing, with a strong interest in the trading philosophies of Warren Buffett and Peter Lynch. Leo also has experience writing articles to help small business owners acquire loans and manage their finances. He regularly contributes to the Stock of the Day analysis.

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