One of the biggest sports brands in the world, NIKE Inc (NYSE: NKE) recently released its financial results for the first quarter ended August 31, 2022 (Q1 FY2023).
Nike’s revenue grew 4% year-on-year (yoy) to US$12.7 billion, which beat analysts’ estimates by US$140 million.
Net income, however, was down by 22% to US$1.5 billion or 93 cents per share but still beat estimate.
Despite the outperformance on the headline numbers, the athletic footwear and apparel company’s share price took a beating as Nike’s declining margins, rising inventories and gloomy guidance caused concern.
Inventories surged by 44% yoy in Q1
Nike’s inventories were up by 44% yoy during its Q1 due to the volatile transit time in North America as well as an intentional decision to stock up on inventories for future seasons ahead of schedule.
The sharp increase was also compounded by the low base effect amid factory closures in Vietnam and Indonesia last year. This led to reduced inventories in its Q1 FY2022 last year.
Declining margins
Nike has attributed the declining gross margin (down 220 basis points to 44.3%) to higher transport and logistics costs.
Aside from that, the strengthening US Dollar also weighed on gross margin while there were also higher markdowns in North America to move out extra inventory.
The higher transportation and logistics costs, as well as the higher markdowns, were mainly due to higher inflation.
This has boosted gas prices while the rising cost of living has affected demand for discretionary goods such as sports shoes.
Guidance points to low double-digit revenue growth
Another concern is the financial outlook provided by Nike’s management.
Nike expects revenue to grow at a low double-digit growth while gross margins are expected to decline between 200 to 250 basis points as compared to a year ago.
For the Q2 FY2023, management expects to see gross margin decline by 350 to 400 basis points as compared to a year ago.
This represents a further decline from the 44.3% gross margin recorded in Q1 FY2023.
Nike’s earnings are not bad but near-term challenges to continue
If you look at Nike’s earnings on its own, it has done fairly well.
The fact that it beat expectations – despite the challenging environment – is a testament to the strong brand that the apparel giant has built.
However, given the current market volatility and the rising interest rate environment, the valuation for Nike could be deemed as expensive by some.
With modest revenue growth and a 12-month forward dividend yield of only 1.2%, Nike is not exactly a screaming buy despite the recent sharp decline.
To put it into perspective, Nike’s share price has declined by 46.2% year-to-date but it is still trading at a forward price-to-earnings (PE) ratio of 27.2 times.
That’s significantly higher than the sector median of 13.2 times. Valuation, however, is at a discount from its 5-year average PE of 36.1 times.
Buy Nike for the long-term value creation
The answer to whether Nike is a buy now depends largely on your investment objective.
If you are looking for a long-term investment into a company that has a strong brand, resilient business model and decent dividend payout, the recent decline in Nike’s share price represents an opportunity for you to buy.
However, if you have a shorter time horizon, I believe that the value creation in the long term might not suit you given the market volatility and challenges the company faces in the near term.
Disclaimer: ProsperUs Investment Coach Billy Toh doesn’t own shares of any companies mentioned.
