NIKE (NKE) Q2 Earnings Top Despite Softness in North America

Shares of NIKE Inc. NKE declined 1.8% in the after-hours session yesterday. While the company topped earnings and sales estimates for the fiscal second quarter, its North America business continued to struggle. This probably hurt investor sentiment. Additionally, the company reiterated previously outlined soft outlook for fiscal 2018.

However, the company’s second-quarter results reflected significant progress on the Consumer Direct Offense, which the company anticipates to continue in the second half of fiscal 2018. Additionally, the company’s strong line-up of product innovations to be launched in the back half of the fiscal year is likely to enhance performance.

Overall, NIKE’s stock has increased 21.7% year to date, outperforming the Consumer Discretionary sector’s growth of 5.9%.

Earnings & Revenues

This athletic apparel, footwear and accessories retailer’s second-quarter earnings per share of 46 cents fell 8% year over year, but surpassed the Zacks Consensus Estimate of 39 cents. This marked the company’s 22nd straight quarter of earnings beat. The company blamed the decline in earnings to gross margin reduction and SG&A deleverage, despite solid top-line growth, a lower tax rate and share count.

Revenues of the swoosh brand owner increased 5% to $8,554 million and beat the Zacks Consensus Estimate of $8,391 million. This was primarily driven by persistent growth at international locations and strength in global NKE Direct business, offset partly by soft North American Wholesale revenues. Sales grew 3% on a currency neutral basis.

Revenues for the NIKE Brand jumped 5% to $8,136 million, while constant-dollar revenues for the brand were up 4%. Results gained from growth in Greater China; Europe, Middle East & Africa (“EMEA”); and Asia Pacific & Latin America (“APLA”), along with continued momentum in Sportswear and growth at NIKE Basketball categories. Notably, Sportswear category registered double-digit revenue growth.

Moreover, the NIKE brand recorded NKE Direct currency-neutral revenues growth of 15% in the fiscal second quarter. The growth in NKE Direct revenues was mainly owing to 29% increase in online sales, 6% comparable store sales growth and addition of new stores.

Additionally, revenues at the Converse brand declined 2% to $408 million owing to fall in North American revenues. This was partially offset by strong international revenues. On a currency neutral basis, revenues dipped 4%.

Costs & Margins

Gross profit improved 2% to $3,678 million, while gross margin shriveled 120 basis points (bps) to 43%. The decline in gross margin can mainly be attributable to foreign currency headwinds and rise in product costs per unit, offset by increase in average selling prices.

Selling and administrative expense rose 10% to $2,768 million on account of higher operating overheads and demand creation expenses. Demand creation expenses increased 15% year over year to $877 million due to higher sports marketing and advertising expenses. Operating overheads rose 8% in the quarter owing to higher administrative expenses, as well as continued investments in NIKE Direct.

Balance Sheet & Shareholder-Friendly Moves

NIKE ended second-quarter fiscal 2018 with cash and short-term investments of $4,304 million, long-term debt (excluding current maturities) of $3,472 million and shareholders’ equity of $11,758 million. Inventories as of Nov 30, 2017, grew nearly 6% to $5,326 million.

In the fiscal second quarter, NIKE bought back 16.7 million shares for $902 million under its four-year $12 billion program that was approved in Nov 2015. As of Nov 30, the company’s total repurchases under the program amounted to 111.8 million shares for roughly $6.2 billion.

Outlook

Going forward, the company expects Consumer Direct Offense to build momentum through the second half of fiscal 2018 in both the United States and international locations. The company stated that its overall outlook for fiscal 2018 remains unchanged. Consequently, it reiterated fiscal 2018 forecasts for revenues, gross margin and SG&A.

For fiscal 2018, reported revenues for the fiscal are still anticipated to increase in the mid-single digits, with gross margin contracting about 50-100 bps.

Reported SG&A is anticipated to increase in the mid-single digit range, including prudent operating overhead management, alongside investing in Consumer Direct offence. Other income and expense, net of interest expense, is likely to be $120 million of expense, while effective tax rate is anticipated in the range of 14-16%.

In third-quarter fiscal 2018, the company expects reported revenue growth to be flat or slightly below the second quarter level due to the timing of new product launches coming late in the quarter. While the company anticipates the underlying drivers for gross margin to improve in the third quarter, currency headwinds and a promotional retail environment across the United States is likely to outweigh margin growth. Consequently, gross margin is projected to decline 125-175 bps in the third quarter.

However, the company expects the significant currency headwinds experienced in the third quarter to moderate in the fourth quarter.

Further, the company expects SG&A expense to increase in the low-double digits range in the third quarter, driven by increased demand creation opportunities and higher operating overheads to boost digital capabilities. Other income and expense, net of interest expense, is likely to be about $30-$40 million of expense. Moreover, the company anticipates significantly higher tax rate in the third quarter, if the U.S. Tax reform is enacted into law.

Zacks Rank & Stocks to Consider

NIKE currently carries a Zacks Rank #3 (Sell). Better-ranked stocks in the same industry include Decker’s Outdoor Corporation DECK, with a Zacks Rank #1 (Strong Buy), Skechers U.S.A., Inc. SKX and Wolverine World Wide, Inc. WWW, both carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Decker’s, with long-term earnings per share growth rate of 10.7%, has surged 43% year to date.

Skechers has advanced a substantial 55.5% in the last three months. The stock has a long-term growth rate of 14%.

Wolverine World Wide has a long-term EPS growth rate of 12.5%. Further, the stock has returned 42.8 year to date.

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