Why is Nike stock falling?
Since the beginning of the year, NIKE, Inc. (NYSE: NKE) fell nearly 40%, a significantly larger drop than the S&P 500 (VOO) and Consumer Discretionary ETF (XLY) to which it belongs.
Weakness of Greater China
For many years, China has been one of Nike’s growth engines. With the exception of Apple (AAPL), there haven’t been many others like Nike (see 2019 article, “Nike: A Rare China Success Story that can Last”). In their article, Urbem Capital laid out Nike’s growth story in China very clearly through FY2019.
|Nike revenue growth in China||Nike revenue growth (excluding China)||Share of Nike China in total revenue|
|FISCAL YEAR 2019||21%||5.3%||15.9%|
|FISCAL YEAR 2018||21%||3.8%||14.1%|
|FISCAL YEAR 2017||12%||5.3%||12.3%|
|FISCAL YEAR 2016||23%||3.8%||11.7%|
|FISCAL YEAR 2015||18%||9.3%||ten%|
|FISCAL YEAR 2014||5%||10.3%||9.4%|
At that time, the future looked bright for Nike in China, where a growing middle-class population that was beginning to prioritize a healthy lifestyle was expected to provide a multi-year tailwind for the company. . This thesis continued in FY20 and FY21, with Greater China experiencing faster revenue growth than Total Nike, at 8% (vs -4%) and 24% (vs 19%) respectively.
The growth story turned in FY22, with growth slowing to 1% in Q1 and in recent Q4 results growth was -20%. From the recent fourth quarter earnings call:
Revenue decreased 20% on a currency neutral basis and EBIT decreased 55% on a reported basis. This follows the most widespread COVID disruption in the region since 2020, affecting over 100 cities and over 60% of our business.
This implies that Nike’s weakness in China is the result of recent COVID-induced lockdowns and restrictions, but that’s not all. Simply put, local sports companies have been taking shares of Nike and Adidas at a rapid pace as Chinese consumer preferences have shifted towards backing their own local giants. Anta saw revenue increase by 39% while Li Ning saw 56% growth in 2021. (Source: Daily Jing) According Focus on China-Britain affairsdomestic brands (such as Anta) benefited from:
- Growing preference (especially among young Chinese consumers) for local brands;
- More control over factories and stores (unlike Nike and other Western companies that use OEMs), being more agile allows them to get a product to market in half the time;
- Improved quality of local brands, eliminating one of Nike’s main selling points.
As such, even with the easing of containment measures in China, Nike is unlikely to return to >20% or even double-digit growth. After all, Nike’s Chinese rivals have continued to grow even during the shutdowns.
US recession fears
Just six months ago, Nike’s US growth was offsetting its Chinese weakness (see Bloomberg article, December 21, Nike wins as U.S. growth helps weather China slump). However, in the last quarter, the US strength waned, with revenue down 5% and EBIT down 18%. The United States is expected to continue to be weak for Nike in the near term as it experiences periods of strength amid declining consumer confidence and growing fears of a recession. With North America and Greater China accounting for 60% of Nike’s revenue, Nike will continue to face headwinds.
This is exacerbated by Nike’s large customer base compared to brands more focused on wealthier customers (e.g. Lululemon and Louis Vuitton) which have seen revenue growth continue at high levels despite recession fears.
Pros: DTC and digital strategy pays off with higher gross margins, higher purchase frequency and higher spend
In 2017, Nike announced its Consumer Direct Offense (CDO) strategy shifting from wholesale distribution (e.g. selling through partners such as Amazon) to “Direct to Consumer” – DTC. This should allow Nike to maintain its relationship with consumers, thus keeping control of all important customer data information as well as the customer experience. More importantly, this should result in higher gross margins.
Nike’s DTC strategy (i.e. NIKE Direct) played a large role, as DTC’s share increased to 38.7%, as it cut around 50% of wholesale distribution partners, e.g. Amazon and Zappos. (Source: Retail Touch Points)
Another key aspect of its DTC push is its focus on digital channels which should “create a much faster pipeline to better serve Nike customers personally and at scale.” (Source: Tissue) Its goal was to reach 30% digital share by 2023, but it has already achieved it in 2021. According to John Donahoe, CEO of Nike, “a consumer who connects with us on two or more platforms (for example, Nike’s multiple apps such as SNKRS, Training Club, Run Club and Nike’s flagship app) has a four times higher lifetime value than those who don’t.”
Nike’s success so far with its direct and digital strategy has so far translated into an increase in gross margin, with gross profit margin hitting a 5-year high. This has so far allowed Nike to offset China’s supply-side gross margin pressures and high ocean freight costs.
… The margin expansion we saw in both NIKE Direct, NIKE Digital and a combination of higher full price sales overall, our gross margins would have increased by more than 100 basis points in fourth quarter… Since the year ’20, our gross margins are up more than 260 basis points, and this includes in fiscal year 22 a headwind of 100 basis points due to the high costs of the sea freight.
The low-hanging fruits/benefits of the DTC and digital strategy appear to have been fully picked, resulting in higher margins, higher order frequency, and higher average order values (AOV). Nike has implicitly agreed, with CEO John Donahoe’s 2020 strategy update – Consumer Direct Acceleration (CDA) as the “digital phase of our Consumer Direct strategy”, and aims to create “a clear and connected digital marketplace… more closely aligned with what consumers want and need”. This refers to Nike trying to engage consumers through non-traditional digital channels such as through Nike Virtual Studios, which creates Web3/Crypto products and experiences, and Nikeland, the virtual world on Roblox that has been visited by 6.7 million players since its launch in November 2021. .
These are important long-term strategies for meeting potential customers where they are, and increased engagement should eventually translate into revenue and profit. However, the key word here is the long term and continued investment in this area should actually curb margin expansion.
Conclusion: wait and see
While Nike continues to do well in some parts of the world – neutral double-digit growth in Korea, Mexico, Southeast Asia, India and Japan, its main growth drivers (US and China ) have stagnated and are not expected to resume growth anytime soon. The lack of near-term catalysts is compounded in that I think his DTC and digital strategy has plateaued (at least in the short term). As such, I would employ a “wait and see” strategy towards Nike, see when China and the US return to growth and will there be continued gross margin expansion, etc., rather than to catch a falling knife.