Eroding profit overshadows strong Nike sales performance

(Source: Bigstock)

Nike’s top-line strong sales growth is being overshadowed by continued weakness on the bottom line, where profit has been sharply eroded and came in a fraction below expectations.

The sports retailer has reported full-year revenue of $51.2 billion, up 10 per cent compared to the prior year, and up 16 per cent on a currency-neutral basis. 

Unfortunately, Nike is facing the headwind of slower demand for sneakers and apparel which is pushing down wholesale orders, driving up inventory, and necessitating more marketing and promotional efforts to drive volume. This has coincided with the usual cocktail of higher costs that is impacting all retailers. Taken together, these things are putting a squeeze on the business. 

The pressure shows up most in terms of profit which, at net income level, fell by 28 per cent this quarter. Nike remains profitable, but there has been a significant deterioration in margins partly thanks to higher promotions needed to clear down excess inventory – which remains a significant issue.

The good news on the inventory front is that levels have fallen a bit from last quarter and are only up fractionally over last year. The not-so-good news is that inventories are running around 23 per cent above the more normalised levels of 2021. Nike has been caught on the hop in terms of the levels of stock it ordered – and it was too slow to react to the more sluggish levels of growth that have come with a challenging consumer economy.

The downtick in demand is falling most heavily on sales through third-party retailers, which is why wholesale revenue declined by 2 per cent this quarter. Unfortunately, this softness does not look like it will dissipate any time soon and this represents a challenge for Nike as it cannot make up for all the deterioration through its direct sales channels.

This is one of the reasons Nike is starting to take a more sympathetic view towards third-party retailers after spending a long time pulling back to focus on direct retail. Basically, the company knows it needs to maximise the number of doors it sells through in order to protect volumes and not lose certain customer segments who do not shop direct. This applies especially to apparel where brand loyalty isn’t as strong as it is for sneakers.

Even so, these actions will not be enough to quickly remedy the inventory overages. We believe that further markdowns and write-downs will be needed as Nike enters its new fiscal year which will heap further pain on the bottom line.

Geographically, Nike has been able to lean more heavily on China this quarter as society has opened up after a period of very strict lockdowns. This bounce back is likely to persist for the next couple of quarters which will give some lift to revenue numbers. However, this benefit is counteracted by slowing growth in North America and Europe, where the consumer remains cautious and constrained. And, unfortunately, China is not the main profit centre for the company so even strong sales growth has a more modest impact on the bottom line.

Overall, Nike is a solid brand, and it is not suffering from an existential crisis. However, it isn’t on the front foot either and has to accept that the year ahead will be one of resetting, retrenching, and reformulating the way it does business.

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