Nike's Winning Game on Home Ground

Gaurav is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Nike (NYSE: NKE) continues to dominate the biggest sportswear market in the world, the US. For some time now analysts have been wondering if the company would be able to continue its growth trajectory in the US. And, the world’s biggest sporting-goods company has proved it once again that it is still the champion at its home turf. Nike’s recent quarter and annual performance provide ample testimony of the fact.

It is this excellent demand and sales trend that will help the company combat and offset the weakness that it is facing at its other most important market, China. Let us take a closer look.

Financial performance

Nike has added yet another earnings beat to its credit with its fourth-quarter results. Just ahead of the earnings release, The Wall Street Journal reported that the company has beaten analyst estimates in 36 out of the previous 40 quarters.

For the fourth quarter, the company reported earnings of $0.76 per share from continuing operations, ahead of $0.74 per share anticipated by analysts at Thomson Reuters. Its revenue came in at $6.7 billion, which is 9% higher than year-ago results on a constant-currency basis.

For the fiscal year, Nike generated revenue of $25.3 billion from continuing operations, an 11% increase on a constant-currency basis. This was on account of an 11% increase in sales of Nike brand, which included a 24% improvement in direct-to-consumer sales. Earnings increased 11% $2.69 per share aided by  better gross margins, a lower tax rate, and share repurchases.

The company’s future orders for the next six months stand at 8% higher than last year.

Strong demand in North America

Demand has been strong in the North American sports-gear segment and Nike has played a big role in fueling that demand. The new innovations that the company has brought to the market, like Flyknit and Lunar running shoes, Dri-FIT fabrications, Nike+ FuelBand movement-tracking wristband, etc., have all been well received.

In fiscal 2013, Nike outperformed the market in most product categories. It reported double-digit growth in footwear, apparel, as well as equipment. It was a record year as the company topped $10 billion in revenue for the first time in North America, a feat that not many can match in many years to come. This is more than five times Under Armour’s (NYSE: UA) 2012 revenue of $1.8 billion. Even Adidas (NASDAQOTH: ADDYY) generated sales of around $4.5 billion (Euro 3.4 billion) in 2012.

Nike has added a spectacular $3.7 billion in incremental revenue in North America in the last three years and $1.5 billion in the last fiscal year alone. And given that the future orders in North America are up 12%, sales will remain strong.

It will be difficult for anyone to beat Nike in North America. The company has been expanding its market share and growing sales at a double-digit rate for the past several quarters.

Footwear will be a growth area

In the US, footwear will be a key growth area. SportsOne Source estimates that sports footwear grew by 5% in 2012, 10% in the first quarter of 2013, and sales are still strong. Nike is the undisputed master of this segment with a market share north of 60%.

The running-shoe segment is a big attraction for both Adidas and Under Armour as well. They command 10% and 2.5%, respectively, of the market and are looking to grow. Adidas’ new Energy Boost sneakers are pitting against Nike’s Flyknit range, while sales of Under Armour’s Spine Venom are gaining traction.

Nike, too, has some big aces up its sleeve. It has hinted that it could come out with an offering that would combine two of its path breaking technologies – Flyknit and Free. This can score huge points for the company.

Margin expansion will continue

Margins are the key earnings driver and Nike’s gross-margin improvement in the fourth quarter from 42.8% to 43.9% was noteworthy. But it faces some tough comparisons from its rivals Adidas and Under Armour.

Adidas has just reported a gross margin of over 50% in its recent first quarter. This was possible due to new more profitable products and better pricing power. Under Armour has also improved its gross margin to 45.9% in its first quarter on account of lower input costs, which offset a negative mix and higher freight costs.

Not to be outdone, Nike is focusing on long-term strategies to boost its gross margins. It is striving to improve manufacturing efficiencies by using more sophisticated techniques that reduce labor components in the process. Rising labor costs are the key threats to margins.

Nike’s Flyknit technology is an excellent example of its manufacturing efficiency. This enables the entire upper part of the shoe to be made from a single thread using a computerized process. This is revolutionary if we consider that the traditional shoe-making process involves stitching scores of small parts together. In addition to saving labor costs, it also creates two-thirds less waste than ordinary running shoes.

Nike has big plans of introducing this technology in other shoe categories and even in apparel. The savings potential from this is phenomenal.

Meanwhile, the company is enjoying better pricing power and has raised prices in several markets. It also benefiting from lower input costs. This together with lower discounting in China and easing currency headwinds are expected to boost margins by 25 basis points in the current fiscal.

China update

Nike has not yet recovered in China and sales excluding currency fluctuations were down 1% in the fourth quarter. The company is trying to set things right by rightsizing inventories and hopes to see improvements in 2014. Future orders in the country are up 3%.

What will be critical in this market is whether Adidas, which is becoming more popular in the country, is able to topple Nike from its top-spot. Adidas’ sales were up 6% in the first quarter on constant currency basis.

Under Armour has also been testing waters in China and has about four stores in the country. But, it is stepping up its international game and China is obviously an area of focus. Nike would need to tie its loose ends before Under Armour can seize an opportunity.

Last word

For Nike, US will be the growth driver. Demand will increase as new products hit the market, while margins get better. The weakness in China will be troubling but it will be offset by the strength in the US. Overall, investors can expect to see the company growing its revenue and earnings over the coming periods, which would to drive the stock higher.

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Gaurav Basu has no position in any stocks mentioned. The Motley Fool recommends Nike and Under Armour. The Motley Fool owns shares of Nike and Under Armour. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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