Margin Erosion for Nike in China Mutes Forecasts
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The world’s leading sports goods manufacturer, Nike (NYSE: NKE), has become the latest victim of the slowdown in Chinese growth. The company predicted a bleak outlook amid falling demand, particularly in China. It has been selling its unpopular products in China at a discount, and it's now clear that this strategy is going to hurt future orders from the country.
Nike is expecting sales to decline by 6%, instead of showing the 1.2% rise predicted by analysts. Total orders for the brand are going to increase by 8% globally, short of analysts’ estimate of 10%. In short, the negative future growth in China will drag on revenues. Moreover, Nike isn’t sure if or when the numbers will improve.
In its recent quarterly results on Aug. 31, net income dropped 12% (its second consecutive decline) from a year ago to $567 million. This translates into earnings per share of $1.23, dropping from $1.36 last year. Total revenues increased by 9.7% to $6.7 billion, while revenues from China and emerging markets increased by 8% each to $672 million and $867 million, respectively. Currently, Nike’s annual earnings from China account to almost 30% of its total earnings.
But it's gross margins that have continued to decline as the industry suffers from oversupply amid increasing labor and material costs. That's why the company's gross margin has now decreased for seven consecutive quarters and stands at 43.5% . Nike is facing tough competition in the Chinese market, particularly from local brands. The declining growth in China was offset by strong numbers from North America, where revenues jumped 23% to $2.71 billion; but the 13% increase in orders here was slightly below analysts’ expectation of 14%.
The drop in margins shows that despite being a powerful brand, Nike is still not able to generate premium prices. This is even more evident for Apple (NASDAQ: AAPL), which, according to Forbes’ recent review, is one of the most powerful brands in the world. But even Apple is witnessing falling average selling prices, which have pulled the company's gross margin from 47.3% in the second quarter of fiscal year 2012 to 42.8% in the third quarter. Net margins dipped below 40% in the 2nd quarter for the first time in over 3 years.
Although the results have beaten most estimates China’s numbers, which Nike considers its growth engine, are indicating problems in the long run. As soon as the news hit the market, Nike’s shares dropped by 1.17% in the first three days of October. Since the beginning of the year, Nike’s stock has seen an overall decline of 1.2%, whereas its closest and probably the only direct rival Adidas Group, the parent of Adidas, Reebok and TaylorMade Golf, is up by 31.2%.
Unlike Nike, Adidas has increased its guidance and is expecting its sales to increase by more than 10% (on a neutral currency basis) in the current fiscal year. Furthermore, Adidas has been able to maintain its already higher gross margin of 47.5% since 2011. However, Nike’s operating margin of 12% is ahead of Adidas’ 8%. Also, Nike has recorded greater ROA and ROE in the past 12 months.
|
Metric |
Nike |
Adidas |
|
EPS (ttm) |
4.60 |
2.41 |
|
P/E (ttm) |
20.71 |
17.98 |
|
PEG (5 years expected) |
2.29 |
2.77 |
|
Return on Assets |
12.20% |
6.37% |
|
Return on Equity |
21.51% |
15.25% |
Nike therefore continues to attract investor’s attention. The company is also likely to go forward with a $2 billion share repurchase plan, which raises 2013 and 2014 earnings forecast to between $5.35 and $6.00 per share. The growth in China will almost certainly slow down, but North America remains a bright star while Nike’s long term prospects in China remain positive, if muted. It remains to be seen if the current glut is temporary.
However, the fact of the matter is that despite being a powerful brand, Nike is not able to charge premium price from its Chinese customers. The company is facing intense competition in the country from local brands that are far cheaper, and Chinese nationalism is a factor in handicapping international brand growth, as many of these consumer industries mature. As the economy slows down, consumers would prefer cheaper and even lower quality products over high-end, expensive goods offered by a leading brand. Nike’s inability to predict an increase in future growth in China underscores the point that its current margin erosion is not going to be a temporary phenomenon.
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PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple and Nike. Motley Fool newsletter services recommend Apple and Nike. 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.If you have questions about this post or the Fool’s blog network, click here for information.
