Diving deeper into Nike
Some of the biggest winners in my investing career share a trend...
As I said on Friday, they've usually come from the times when I've been able to purchase the stocks of great companies that encounter short-term (cyclical) difficulties that that market wrongly thinks are long-term (secular) issues and thus crush the stock.
I then shared a "first look" of one potential candidate: apparel giant Nike (NKE).
The company is a great long-term growth story whose stock has been crushed – falling by nearly 60% since it peaked almost three years ago.
As I showed in a number of charts, over the past two decades Nike has grown revenue and earnings strongly, generated massive free cash flow, bought back 29% of its shares, and maintained a strong balance sheet.
Today, let's take a deeper look at the company, what went wrong, and whether the stock might be a good buy at current levels...
I'm somewhat embarrassed to admit that I had never taken a close look at the stock because it was always so richly valued and almost never sold off.
But it sure did after reporting fourth-quarter earnings on June 27...
Revenue was down 2% (flat on a constant-currency basis), though an increase in gross margin and a decrease in the tax rate led to a 45% increase in net income.
So why did the stock crash 20% the next day? Because management issued shockingly bad guidance for the 2025 fiscal year. As CFO Matthew Friend said during the earnings call:
We expect first-quarter revenue to be down approximately 10%. This reflects more aggressive actions in managing our classic footwear franchises; continuing challenges on Nike Digital; muted wholesale order books, with newness not yet at scale; a softer outlook in Greater China; and a number of quarter-specific timing factors.
And for the year, as he continued:
... we now expect fiscal '25 reported revenue to be down mid-single-digits, with the first half down high single-digits. Foreign exchange headwinds have also worsened and will now have a one-point translational impact on revenue in fiscal '25.
Turning to gross margin, we expect full-year expansion of approximately 10 to 30 basis points on a reported basis. This reflects benefits from strategic pricing actions and lower product input costs, partially offset by supply chain deleverage, channel mix shifts, and net foreign exchange impact.
We expect full-year [selling, general, and administrative expenses] growth to be up slightly versus the prior year, as we increase investment in demand creation to ignite brand momentum and maximize reach and impact, while holding operating overhead largely flat.
In other words, a decline in revenue combined with rising costs is leading management to project a substantial 21% decline in profits from $3.95 per share (adjusted for a one-time restructuring charge) to $3.12 per share.
Investors are no doubt wondering what on Earth is going on...
This Wall Street Journal article right after Nike reported earnings starts to provide an explanation: How Nike Missed the Boom in Running Culture. Excerpt:
Nike, which has long monopolized the attention and wallets of avid runners, in recent years shifted its focus to other areas of its business including the release of limited-edition sneakers. Competitors swooped in, resulting in an increasingly fragmented market that has dented Nike's finances and prompted a strategic reset at the sneaker company.
Nike on Thursday reported an unexpected sales decline in its latest quarter and cut its revenue outlook for the year, citing lighter traffic to stores and worsening macroeconomic conditions in China. Sales grew 1% for the full year – its worst results in more than two decades excluding the first year of the pandemic and the 2008-09 financial crisis. The results sent shares down more than 10% in aftermarket trading.
Executives acknowledge they lost ground in the critical running category and say they are doubling efforts to regain a stronger grasp of the market. They are betting that a new line of shoes will give it a boost during the Paris Olympics this summer.
I actually like to see articles like this when I'm looking a beaten-down stocks because they often indicate that a stock has hit rock bottom.
As legendary investor Bill Miller once said, "If it's in the papers, it's in the price."
For more insight, I found this recent LinkedIn post by Massimo Giunco, a brand manager who was a senior executive at Nike for 25 years until he left in 2022: Nike: An Epic Saga of Value Destruction. He blames Nike's travails on CEO John Donahoe, writing:
The story started on January 13th, 2020, when John [Donahoe] became CEO of Nike, replacing Mark Parker. Together with Heidi O'Neill, who became President of Consumer, Product and Brand, he began immediately to plan the transformation of the company.
A few months later, after hist first tour around the Nike world, the CEO announced – via email – his decisions (using the formula "dear Nike colleagues, this is what you asked for..."):
1) Nike will eliminate categories from the organization (brand, product development and sales)
2) Nike will become a [direct-to-consumer ("DTC")] led company, ending the wholesale leadership.
3) Nike will change its marketing model, centralizing it and making it data driven and digitally led.
To implement all of that, the CEO also announced a major reorganization of the company which took place in two waves from August 2020 until March 2021 (US first, the rest of the world after).
Giunco then critiqued each of these steps, starting with "Elimination of categories":
In 6 months, hundreds of colleagues were fired and together with them Nike lost a solid process and thousands of years of experience and expertise in running, football, basketball, fitness, training, sportwear, etc., built in decades of footwear leadership (and apparel too). Product engine became gender led: women, men, and kids (like Zara, GAP, H&M or any other generic fashion brand).
If today, we talk about lack of innovation and energy in product creation, well, we know exactly what originated all of that.
He then continued with "End of Wholesale leadership":
For the first time in Nike history, long term vision wasn't about sustainable growth anymore driven by Products, Brand and Marketplace leadership. It was about the supremacy of DTC, led by digital. Period.
At that moment, people couldn't exactly understand the impact of it, and if it was confidence, overconfidence, megalomania, genius, madness or just a mistake.
The marginalization of the wholesale business was very easy to achieve. Nike just began to terminate hundreds of agreements with many local business partners or reduced the business they had with them (selling in less products, and/or diverting premium products to Nike Direct). And they did it globally, showing the middle finger to partners Nike had worked together for decades in any part of the globe and brutally downsizing the number of people working for the sales teams in local country teams.
And as he went on to say:
The CEO of Nike doesn't come from the industry. So, probably he underestimated consumer behavior and the logic behind the marketplace mechanisms of the sport sneakers and apparel distribution. Or wasn't aware of them. At the end, he is a poorly advised "data driven guy", whatever it means.
It is more difficult to understand why the President of the Consumer, Product and Brand, a veteran of the industry, one of the creators of the Women's category in Nike, a professional with an immense knowledge of the company and the business [Heidi O'Neill], approved and endorsed all of this. Maybe, excess of confidence. Or pure and simple miscalculations... hard to know.
The truth is that together, John and Heidi created a cannibal ecosystem that ate brand equity, product equity, gross margin, market share, demand creation budget and consumer connectivity. In just three years...
Thirdly, Giunco covered "Lead with Digital Marketing":
Nike has been built for 50 years on a very simple foundation: brand, product, and marketplace. The DC Investment model, since Nike became a public company, has been always the same: invest at least one tenth of the revenues in demand creation and sports marketing. The brand model has been very simple as well: focus on innovation and inspiration, creativity and storytelling based on athletes-products synergy, leveraging the power of the emotions that sport can create, trying to inspire a growing number of athletes* (*if you have a body, you are an athlete) to play sport. That's what made Nike the Nike we used to know, love, admire, professionally and emotionally.
And as he continued, a change happened in 2020:
... the brand team shifted from brand marketing to digital marketing and from brand enhancing to sales activation...
[The chief marketing officer of that time] made "Nike.com" the center of everything and diverted focus and dollars to it. Due to all of that, Nike hasn't made a history making brand campaign since 2018, as the Brand organization had to become a huge sales activation machine.
An example? The infamous "editorial strategy" – you can see the effects of it if you visit its archive, the Nike channel on YouTube or any Nike account on Instagram – generated a regurgitation of thousands of micro-useless-insignificant contents, costly and mostly ineffective, all produced to feed the bulimic digital ecosystem, aimed to drive traffic to a platform that converts a tiny (and when I say tiny, I mean really tiny...) fraction of consumers who arrive there and disappoints (or ignores) all the others.
Giunco concluded by calling for the ouster of Donahoe and O'Neill:
What happened on June 28th at Wall Street is just the result of what was decided four years ago. And for sure, this is not even the last episode. We don't know what would have happened if certain decisions had not been made and implemented. And we don't even know why those decisions were made. What we know is what we saw. And what we saw is an epic saga of value destruction, harming Nike's brand mental and physical availability, in just 3 years, made by a team of executives led by John [Donahoe] and Heidi O'Neill.
If they are removed, he believes the company can be turned around. As he said:
At the end, this is mainly a Wall Street "crisis". Investors are disappointed and mad at the company leaders who have wasted an unbelievable amount of financial value for nothing in return and destroyed the reputation of Nike as growth company.
At the same time, a huge number of consumers is still there, thinking that "the swoosh" is somewhat cool. Nike is still one of the most famous and popular brands in the world. Nike is still the market leader of its industry. Nike still makes $5bn of earnings before interests and taxes every year ($5.7bn in FY24) and doesn't have a dollar of debt. Nike has a history of unbelievable comebacks.
However, Giunco also noted the long road ahead:
It will take years (and a lot of investments – I mean, it won't be a free ride) to:
- re-establish the lost leadership in product creation (they lost the competence, not only the focus).
- re-gain the ability to influence and drive the marketplace, occupied now by new, agile, and profitable brands (without considering that many wholesale partners are angry at Nike after being abandoned and in some cases marginalized and/or insulted).
- detox the "swoosh" from the performance marketing addictive abuse.
- become again a beacon brand (many brilliant marketers were "kindly" invited to leave over the last 4 years, those left are masters of sales activations, local teams have been canceled or downsized, the "brand magic" competence is gone and needs to be rebuilt... and it won't happen in a quarter).
Tech and financial blogger Trung Phan commented on Giunco's analysis, writing in a post earlier this month:
Of course we should take Giunco's diss track with a few grains of salt. He knew a lot of Nike people that were fired and clearly has quasi-beef with the new management. He's also a brand guy, which competes with direct response ads if the marketing budget is largely fixed.
But every point that Giunco makes sounds reasonable. Nike's digital focus seems to have commoditized the product, impacted the brand perception and created an opening for competitors.
Phan sees reason for optimism. As he continued in his post:
One sign that Nike is moving in the right direction is the much-talked about Olympics ad ("Winning Isn't For Everyone"). The commercial talks up traits that are common among winners but are often socially frowned upon (selfishness, obsession etc). It's edgy, risky and more memorable than anything Nike has done in recent years. It's also narrated by Willem Dafoe, so you get a visual of the Green Goblin from Spider-Man while watching the ad.
Meanwhile, this Reuters article from last week speculates that Nike could benefit from the Olympics: Nike sees gold rush with summer Olympics driven website visits, sales. Excerpt:
The summer Olympics is turning out to be a rare win for Nike as the global sporting event has helped boost demand for the sportswear giant's new launches and edge out competition, website searches from research firm Similarweb showed.
In the opening week of the Olympics, from July 26 to August 1, Nike and Puma managed to increase visits to their direct-to-consumer sites, while Adidas, Hoka and On all saw their visits decline compared to the week before, according to Similarweb.
The visits peaked on July 31 to 2 million, following U.S. gymnast Simone Biles clinching her seventh Olympic gold medal after the United States earned their third gold in the women's team event.
Out of those visits to Nike.com, 86,900 included a sale, while Adidas had a total of 532,500 visits with only 3,600 likely converted into product purchases, the data showed.
In conclusion, I'm inclined to stay on the sidelines with Nike's stock at these levels for two main reasons...
- First, the stock isn't particularly cheap – trading at 23.8 times this year's earnings estimate of $3.12. Even after the nearly 60% drawdown from the 2021 peak, that valuation is still too rich for me.
- Second, as long as the guy responsible for Nike's woes – CEO Donahoe – is still in charge, I have little confidence that he'll be able to admit his mistakes and fix them. I would want to see a change in leadership – or at least clear evidence that current leadership is on the right track to fix issues.
But here at Stansberry Research, my team and I at our flagship Stansberry's Investment Advisory newsletter will keep an eye on Nike. If and when we think it's time to buy, our subscribers will be the first to know.
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Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.