Even the mightiest stumble sometimes, and the stock of iconic footwear maker Nike (NYSE: NKE) is faceplanting in 2022. Shares are down over 34% since the start of the year, making it the worst-performing stock in the Dow Jones Industrial Average index.
Although it's bounced off its lows, Nike's recent earnings report shows it's experiencing turbulence just as consumer spending is slowing. The question investors need to ask is whether the stock's lowered valuation makes it a buy, or whether they should wait because there is more air below the Air Jordans maker?
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Inventory piling up
Nike was trending lower long before its fiscal 2022 fourth-quarter earnings came out at the end of June, and that report sent shares careening lower on the news. The big concern was the buildup in inventory because rampant inflation, elevated gasoline prices, rising interest rates, and a looming recession all point to consumers pulling back on their discretionary spending.
That showed up in Nike's results as inventory jumped 23% even as sales fell 1% and per-share profits were down 3% for the period. Arguably more worrisome was Nike's warning that it would need to be more promotional to lure in customers as a means of lowering inventory, which suggests further pressure will be put on profits in the quarters to come.
The point was hammered several times during the conference call, but CFO Matthew Friend told analysts that Nike's focus is on returning to a healthy "pull market" where consumers more pro-actively find their way to its products.
It sounds like investors will be suffering through at least one, maybe two quarters, before equilibrium is achieved. Yet if the recession deepens, and some economists think it will, Nike's off-balance status could last longer than analysts hoped.
Profits continue to be pressured
Margin pressure is certainly going to be with Nike for some time as the apparel maker said it is expecting gross margins for fiscal 2023 to be 50 basis points lower than 2022, which itself was 80 basis points beneath 2021.
Although it expects higher pricing and the ongoing shift to a more direct-to-consumer (DTC) business helping profits, Nike's transportation costs alone will hit it with a 100-basis point charge. Plus, companies like Nike with significant international market exposure will suffer because of the strong U.S. dollar that will impact currency exchange rates. Nike says foreign exchange rates will impact margins by 30 basis points this year.
Although Nike's DTC move has helped improve margins overall, with the apparel company pointing to a 260-basis point improvement, there are limits to how far it can go, and Nike has already shifted to being a partner once more with wholesalers, such as connecting its membership program with Dick's Sporting Goods.
Nike has a tightrope to walk because, while it enjoys the control it has over customer data, retail partners expand the universe of customers it can reach, and that may be of greater concern for Nike now.
An expensive stock still
Nike is an iconic brand; in fact, it's the most valuable apparel brand in the world, according to Brand Finance, and has been the top brand since tracking such values began. So while its stock should probably be afforded a premium, going for 29 times trailing earnings, 23 times next year's estimates, and 36 times the free cash flow it produces seems a bit rich.
Swollen inventories, a still-snarled supply chain, higher costs, margin pressures, and a looming recession all point to near-term headwinds that suggest the stock may go for better prices in the quarters to come.
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Rich Duprey has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nike. The Motley Fool has a disclosure policy.
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