We are maintaining our BUY rating on Nike Inc. (NYSE: NKE) and raising our price target to $165 from $140. Nike’s strong brand and product pipeline have enabled it to raise prices and increase sales of both apparel and footwear. We also believe that some retailers seeking to boost weak sales are turning to Nike to increase customer traffic, increasing NKE’s bargaining power as a supplier. Meanwhile, in response to changing purchasing trends, Nike is beefing up its direct-to-consumer (DTC) channel (company-owned stores and website). We expect DTC sales to grow at a high-teens pace over the next two years.
Over the long term, we expect Nike to continue to dominate the athletic apparel and footwear market, and note that it has a particularly strong presence in high-end footwear thanks to its marketing strength and endorsements from famous athletes. Although the industry remains fiercely competitive, we expect the company to build on its dominant position through its globally recognized brand, innovative products, economies of scale, and rapid growth in emerging markets.
On December 18 after the close, Nike reported fiscal 2Q21 revenue and EPS that topped estimates by wide margins. Revenue of $11.2 billion was up 9% from the prior year as reported and 7% on a currency-neutral basis. The consensus estimate had called for revenue of $10.54 billion. Digital sales were up 80% in constant currency and revenue in China rose 19% in constant currency. NIKE Direct sales rose 30% to $4.3 billion, with strength in all regions. The reported gross margin decreased to 43.1% from 44% a year earlier due primarily to promotions aimed at reducing excess inventory, and restructuring costs related to a prior reorganization. These headwinds were partially offset by higher margins on full-price products. The consensus estimate had called for a gross margin of 42.8%. Adjusted 2Q earnings were $0.78 per share, up from $0.70 a year earlier and $0.16 above consensus.
In FY21, management expects revenue to increase at a low-teens pace. It projects a 35-basis-point foreign exchange headwind, but still looks for gross margins to increase 50 basis points. SG&A is expected to increase at a low single-digit rate, while the tax rate is projected to be in the mid-teens.
As discussed in a previous note, due to coronavirus uncertainty, the company suspended share buybacks in March.
In FY20, revenue decreased 4% to $37.4 billion (down 2% on a currency-neutral basis) due to the effects of COVID-19, particularly in 4Q20. Diluted EPS fell 36% to $1.60, reflecting lower sales and the negative margin impact of COVID-19.
EARNINGS & GROWTH ANALYSIS
Nike organizes its business operations by geography. (All revenue growth figures below are in constant currency.) In fiscal 2Q21, North American revenue increased 1% to $4.0 billion, and topped the consensus estimate of $3.98 billion. In China, revenue rose 19%, to $2.3 billion, driven by higher e-commerce sales and the reopening of the Chinese economy. The consensus estimate had called for sales in China of $2.11 billion.
In the Europe, Middle East and Africa region, revenue increased 12% in constant currency, to $3.0 billion, well above the consensus estimate of $2.61 billion. In the Asia Pacific & Latin America segment, revenue increased 5% to $1.47 billion. The consensus estimate had called for revenue of $1.27 billion.
E – commerce revenue was impressive in 2Q21, rising 80% in constant currency from the prior year. The NIKE brand saw revenue rise strongly to $4.3 billion, reflecting triple-digit growth in North America and double-digit gains in China and EMEA. However, these positives were offset by declines in the wholesale business. Converse brand revenue fell 4% on a currency-neutral basis, or 1% as reported, to $476 million. The consensus estimate had called for revenue of $459 million.
The 2Q gross margin decreased 90 basis points to 43.1%, reflecting efforts to clear excess inventories resulting from weakened demand attributable to COVID-19, and costs related to a reorganization. Second-quarter selling and administrative expense fell 2% to $3.3 billion. As a percentage of revenue, selling and administrative expense totaled 29.1%, down from 32.2% in the prior-year period. The consensus estimate had called for selling and administrative expense of 31.1% of revenue. Demand creation expense fell 17% year-over-year to $729 million, reflecting the absence of sporting events in the quarter. This was well below the consensus estimate calling for demand creation expense of $813 million.
We are raising our FY21 EPS estimate to $2.90 from $2.75 based on the much stronger than expected 2Q21 earnings and management’s full-year sales guidance. We are also raising our FY22 estimate to $3.80 from $3.70.
Over the long term, we expect growth at Nike to be driven by the Jordan Brand, which represents more than 12% of sales; continued innovation; expanding e-commerce sales, and renewed growth in China.
FINANCIAL STRENGTH & DIVIDEND
Our financial strength rating for Nike remains High, the top of our five-point scale. Nike has a strong balance sheet, moderate debt, and enough cash to cover all current obligations. Long-term debt at the end of fiscal 2Q21 was $9.41 billion; the long-term debt/capital ratio was 47%. Cash and equivalents and short-term investments increased to $11.8 billion from $3.5 billion. Inventories totaled $6.1 billion, down 2% from the prior year.
At the end of the quarter, liquidity totaled $15.8 billion.
Nike plans to maintain a dividend payout range of 25%-35%. It recently raised its quarterly payout by 12% to $0.275 per share, or $1.10 annually, for a yield of about 0.8%. Our dividend estimates are $1.07 for FY21 and $1.16 for FY22.
The company has a share buyback program.
MANAGEMENT AND RISKS
Mark Donahoe succeeded Mark Parker as president and CEO on January 13, 2020. Andrew Campion is the CFO. He joined Nike in 2007 as VP of Global Planning and Development and was named CFO in 2010.
Nike’s earnings face risks from rising input, labor and freight costs, as well as from decreased consumer spending. Sales have been hurt by economic weakness in Europe, and are now facing pressure from the coronavirus pandemic.
Nike’s global portfolio is diverse enough to withstand weakness in any individual market, but also exposes the company to exchange rate risk.
Headquartered in Beaverton, Oregon, Nike develops and markets footwear, apparel, athletic equipment, and accessories. Its products are sold through a mix of independent distributors, licensees and subsidiaries to some 18,000 retail accounts worldwide.
We think that NKE shares remain attractive at recent prices near $145, near the high end of their 52-week range of $60-$146. From a technical standpoint, the shares are in a bullish pattern of higher highs and higher lows that dates to October 2017.
NKE shares are trading at 38-times our revised EPS estimate for FY22, at the top of the five-year historical range of 20-38 and above the average for other apparel and footwear companies. However, given ongoing strength in China and recovery in the U.S., we see continued upside for NKE and are raising our target price to $165.
On December 21, BUY-rated NKE closed at $144.02, up $6.74.