Nike (NKE) Beats on Q4 Earnings; Weak Revenues Hurt Stock

NIKE Inc. NKE reported third-quarter fiscal 2017 results, wherein earnings topped estimates for the nineteenth straight quarter but revenues fell short. Both the top line and bottom line improved year over year.

The lower-than-expected revenues mainly reflected the rise in competition for Nike’s basketball shoes in North America, which is the company’s largest market, and also the shifting retail backdrop. The company reported a 3% rise in North American revenues in the quarter. NIKE has been unbeatable in the U.S. footwear segment for long, thanks to the popularity of its namesake and Jordan brands. However, the company is lately losing market share to Adidas AG ADDYY and Under Armour Inc. UAA given their schedule of new product launches and efforts to redefine brands.

This has also led to the company reporting lower gross margins in the quarter. Further, it has provided a soft sales growth outlook for fourth-quarter fiscal 2017 due to the competitive environment and challenges in the retail segment.

Consequently, NIKE’s shares fell about 3.7% in the after-hours trading session following the solid fiscal third-quarter results on Mar 21. Overall, the company’s stock has increased 12.9% year to date, significantly outperforming the Zacks categorized Consumer Discretionary sector’s growth of 8.4% in the same period.

Earnings & Revenues

This athletic apparel, footwear and accessories retailer’s third-quarter earnings per share of 68 cents rose 24% year over year, beating the Zacks Consensus Estimate of 52 cents. Earnings were fueled by sales growth, selling & administrative expense leverage, lower tax rate and a 3% decline in average share count, somewhat offset by a drop in gross margin.

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Revenues of the swoosh brand owner advanced 5% to $8,432 million in the reported quarter but lagged the Zacks Consensus Estimate of $8,446 million. Sales grew 7% on a currency neutral basis. The year-over-year growth was backed by superb global demand for the NIKE Brand portfolio across all regions. Additionally, results benefited from strong eCommerce growth.

Revenues of the company’s NIKE Brand increased 7% on a currency neutral basis to $7,923 million. The segment gained from a double-digit increase in Western Europe, Greater China and Emerging Markets, along with solid growth across Sportswear and Jordan Brand categories.

Moreover, the NIKE brand’s Direct-to-Consumer (“DTC”) revenues improved 13% in the quarter mainly on the back of robust online sales growth, 6% comparable store sales growth and expansion of new stores.

Additionally, revenues at the company’s Converse brand rose 3% on a currency neutral basis to $498 million, chiefly driven by North American growth.

The NIKE Brand’s future orders declined 4% on a reported basis and were down 1% on a currency-neutral basis. While future orders form an important part of the company’s operating model, its relevance and dependence in gauging revenue growth has declined due to many factors including, the growth in eCommerce and the non-inclusion of sales of its Converse brand, NIKE Factory Stores and shorter lead-time businesses.

Costs & Margins

Gross profit improved about 2% to $3,750 million, while the gross margin shriveled 140 basis points (bps) to 44.5%. The decline in gross margin is attributable to higher product costs, foreign currency headwinds and increased off-price sales mix, which neutralized the gains of higher average selling prices.

Selling and administrative expense fell 3% to $2,496 million on account of lower operating overhead costs and demand creation expenses. Operating overheads dropped 1% in the quarter as lower bad debt expenses and lower administrative costs more than mitigated the expenses related to investments in the DTC business.

Balance Sheet & Shareholder-Friendly Moves

NIKE ended the quarter with cash and short-term investments of $6,160 million, long-term debt (excluding current maturities) of $3,472 million and shareholders’ equity of $12,722 million. Inventories as of Feb 28, 2017, grew nearly 7% to $4,932 million.

During the fiscal third quarter, NIKE bought back 8.9 million shares for $475 million under its four-year $12 billion program that was approved in Nov 2015. As of quarter end, the company’s total repurchases under the program amounted to 64.9 million shares for roughly $3.6 billion.

Looking Forward

Though NIKE is facing various hurdles, the company remains confident of driving sustainable and profitable capital efficient growth over the long term. Looking into the future, the company has embarked upon a new “triple-double” strategy, focused on doubling the cadence and impact of innovation, doubling the speed to market, and doubling NIKE’s direct connection to consumers in the marketplace.

However, the company exhibited caution in providing fiscal fourth-quarter guidance as it expects the rising competition and difficult retail environment to take a toll on the top line. The company projects sales growth in the mid-single digit range in the fiscal fourth quarter, slightly short of the growth reported in the third quarter. On a currency neutral basis, it anticipates revenues to increase in the high single-digit range. During the fourth quarter, the company expects to see tremendous sales growth internationally, including Greater China, Europe and Emerging markets.

However, NIKE remains cautious on sales projections for North America. The company plans to tighten supply of newly released products in North America to maintain demand.

For fourth-quarter fiscal 2017, gross margin is projected to fall by nearly 150 to 175 bps in the quarter, mainly due to adverse currency movements. Further, SG&A expenses for the fourth quarter are estimated to remain flat year over year, backed the productivity gains from the ongoing Edit-to-Amplify initiative. Further, the company expects interest expense of about $15 million and tax rate of 22% in the fourth quarter.

Nike, Inc. Price, Consensus and EPS Surprise

Nike, Inc. Price, Consensus and EPS Surprise | Nike, Inc. Quote

Zacks Rank & Stock to Consider

NIKE currently carries a Zacks Rank #3 (Hold). A better-ranked stock in the same industry is Francesca's Holdings Corporation FRAN, carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

With a long-term EPS growth rate of 13.8%, Francesca's Holdings has outperformed earnings estimates consistently in the trailing four quarters, with an average beat of nearly 26.6%.

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