How This Sportswear Company Can Keep Growing
A few years ago, one of the main attractions of Western consumer goods stocks was their potential to aggressively grow sales in emerging markets. That story is still in place, but somehow Nike has managed to flip the script in recent years by generating more of its growth from mature markets.
This trend continued with the latest first-quarter results, with Nike announcing double-digit growth in North American and Western European orders. The stock hit an all-time high in response, but is it time to take profits? Moreover, can it continue to rely on mature markets for growth?
Nike flips the script
There are three key takeaways from the recent results, and each of them serves as a marker for what Nike needs to do going forward.
First, its mature markets are out-performing. A look at segmental earnings before interest and taxes (EBIT) reveals that growth this year has come from North America and Western Europe.
Source: Company Accounts
Western Europe is now generating more profits than Greater China or the emerging markets segments. Furthermore, Nike reported future orders of 11% and 12%, respectively, for North America and Western Europe. Meanwhile, Greater China and emerging markets futures grew at a less impressive 2% and 7%, respectively.
The second takeaway is the ongoing out-performance of footwear versus its other categories in regions outside of North America. The one key exception in the quarter was China (the only area where apparel notably outgrew footwear), and I'll come back to this important point later. For now, focus on how much better footwear is doing.
Source: Company Accounts
This trend is probably going to reverse somewhat because Nike will come up against some easier comparisons with apparel in the upcoming quarters.
With regards to North America, apparel grew at the same 9% rate as footwear, and management declared itself "super excited" by the performance in its women's business. This is something that might concern yoga-gear maker Lululemon Athletica . After suffering quality issues with its black yoga gear, Lululemon was susceptible to losing some market share. This sort of issue is critical for Lululemon, because it's positioned as a premium seller in the marketplace.
The third takeaway was the return to growth in Western Europe. The 8% revenue growth rate (at constant currency) is pretty impressive considering it came up strong growth generated last year by football (soccer) sales inspired by the European football championships. Outside of the World Cup, the European competition is the largest in the World, and features all of the top players outside of South America. .
What does it mean for Nike?
Clearly, Nike needs to improve its performance outside of North America. With this in mind, the return to form in Western Europe is a good indicator for Nike's plans in China. Nike is undertaking a similar kind of strategy reset in China to what it successfully did in Western Europe.
It would be churlish to doubt that Nike can improve its performance in China through simple 'blocking and tackling' management initiatives. For example, things like merchandising, improved product selection, and improving logistics were all discussed on the conference call. On the other hand, there are a couple of short-term concerns.
First, Nike's strong performance in North America relates to its successful sponsorship of high profile American athletes in sports like basketball or American football. It's highly unlikely that LeBron James or Kobe Bryant are going to resonate as well with Chinese consumers. Second, when questioned about the future footwear/apparel mix in China on the conference call, Nike's management replied:
So we'll have the more targeted mix of products, but the ratio of footwear and apparel -- we're not seeing a dramatic shift in that ratio. That said, we see tremendous upside in the apparel business in China for Nike to move forward and frankly around the world.
It doesn't look like Nike will specifically address why apparel is outperforming footwear in China, and this may make its strategic reset a bit harder to execute.
Where next for Nike?
Nike's stock price is at an all-time high, and even when compared to a company like outdoor-clothing company VF , Nike's valuation looks a bit rich.
VF is arguably more attractive than Nike because it has a wider and more diverse range of brands. When market conditions are difficult for one brand, it can focus on another in order to drive growth. Whereas with Nike right now, it really is all about footwear, and its more mature geographies in particular. VF has a mix of powerful outdoor brands (such as Timberland, Vans, and The North Face) and jeanswear with which it can generate growth across the cycle.
What Nike needs to just do
If Nike is going to continue to justify this valuation it is going to have to execute better in China and emerging markets. Fortunately, the World Cup takes place in an emerging market, and Nike is well placed as the sponsor of the powerful Brazilian host team. However, the market is likely to have priced this in by now.
Therefore the 'swing' factor in deciding to buy the stock must be your confidence over the company's ability to turn things around in China. Furthermore, Nike will need to continue to grow at a rapid clip in its mature markets. If you think Nike can just do it, then the stock probably has further to run. For cautious investors, however, now might be a good time to take a little profit off the table.
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The article How This Sportswear Company Can Keep Growing originally appeared on Fool.com.Lee Samaha has a position in Nike. The Motley Fool recommends Lululemon Athletica and Nike. The Motley Fool owns shares of 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.
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