Nike: ‘The demand is very much there,’ retail analyst says

BMO Capital Managing Director & Senior Retail Analyst Simeon Siegel joins Yahoo Finance Live to discuss Nike’s direct-to-consumer approach, the footwear manufacturing company’s growing expenses, and the outlook for the company overall.

Video transcript

JULIE HYMAN: Despite an overall increase in consumers using Nike's direct channels to buy their shoes, gross margins and earnings before interest and taxes fell meaningfully. That's according to new research from BMO Capital that cites the 10-Q and suggests that after three years of going all in on its direct channels, Nike might need to reconsider that DTC and wholesale strategy. Here to weigh in is the man behind the note, BMO Capital Markets managing director and senior analyst specializing in retail that's Simeon Siegel. Simeon, it's good to see you.

This has been such an interesting move that we've seen over the past few years from Nike. And it's had all kinds of effects on its relationships with its vendors like a Foot Locker, for example. Does it need to pivot backwards or what do you think a new strategy needs to look like here?

SIMEON SIEGEL: Gosh, Julie, you just made me probably the only person in the world that can make Nike sound less fun here. Like the amount of words there, technically speaking. Now so you and I have been talking about this for a bit. I think that there is this view that you eliminate wholesale, you eliminate a fee. That must naturally be better. And it is surprising, but mathematically, it just doesn't work.

And so what we're seeing is we're seeing the growth-- someone is paying that cost. Now it's Nike as opposed to letting someone else do it for them. And so I think it was this magic word called omnichannel, and we forgot about it. We started gravitating toward e-com, and we started gravitating towards direct.

And the reality is Nike is where they are. They are one of the largest sellers of products in stores in the world because they embrace all the channels. And so I think you have to be strategic. Don't sell through everyone. Don't just give away your product simply to sell more units. But to say we're just going to move away from wholesale, I mean, that we are seeing mathematically, as damaging.

- Simeon, I've had a lot of great conversations with the President of consumer and marketplace over at Nike, which is Heidi O'Neill. And particularly, the environment that they've been able to take advantage of with direct to consumer and growing out that Nike direct business, it's been one that was largely started by some of their other competitors. And Nike, of course, had the size, the scale to be able to make a huge, not just ripple effect, but a wave within the way that athletic footwear and apparel was then sold to their own customers.

But we've seen kind of a pullback in some consumer discretionary dollars. So my question to you is, how much of the growth story right now is really just hinging on that pullback in some of the demand? And people looking around, perhaps their apartment here in New York City where you only got one closet, saying, you know what? I might have too many shoes at this point.

SIMEON SIEGEL: No. God forbid. God forbid. No. Listen, I think there's a lot of different aspects. I think we're watching wholesale do really well. I think we can't go-- we can't talk about Nike strength right now without acknowledging some weakness at a very large competitor because they are no longer selling Yeezys.

I think there is some element here where there is a timing factor. But I think more than anything, Nike has never struggled to sell more units. I think the question is where, how, and how much do you get for it. That's the fascinating stat that we saw this quarter. Nike revenues were up 14%. That is a huge number off of a very huge base.

The problem? Nike profit. The actual operating profit dollars were down almost 14%, too. And so like, Julie, it goes back to the conversation you and I have been having throughout the pandemic, of the sell less, charge more. If you sell more, and you make less money for it, is it a good trade? And so I think it's fascinating.

I think the demand is very much there. I think the question becomes, how do we turn that into healthy profits? And so to your earlier point, the size and scale, no one markets better than Nike. No one can ultimately compete with their check size, whether it's R&D, whether it's marketing. And so the question becomes, do they compete against themselves?

And so that's where I think what we are seeing is the sequentially improving inventory. The sequentially improving gross margins. Less bad than it was. But what we need to internalize is also this growing expense bucket. And so when you're operating overhead is growing faster, that is what happens when you go direct. When you go direct, what you're basically is saying is I want to recognize the full revenue. I don't want to share the product margin.

But by the same token, I'm willing to absorb all of the operating expenses. Letting other people absorb some of that operating expenses is how Nike got to the size and scale and profits of where they are in the first place.

JULIE HYMAN: And then there's another sort of big picture question that I have been asking periodically, which is, are we anywhere near peak trend with this sort of the shoe craze and the Nike hotness in particular? Still upward sloping here?

SIMEON SIEGEL: And I think, we'll see at the box office. I haven't seen the movie yet, but we're talking about the origin story of Nike hitting theaters now. I mean, I don't know if that's a jump the shark or if that's a feel the momentum story. But I think what they have been is historically fantastic. Nike hasn't always had a smooth run upwards.

What they've been historically fantastic at is watching competitors emerge, taking their time to recreate the product that they need to create, find what the trend is by going back into their archive, but also embracing new technology. Using that spin. Using the size and scale. And then effectively implementing the next phase. I mean, remember there was-- I don't remember. five plus years ago when Adidas came in and created the Ultraboost and all of a sudden there was competition.

Many years earlier, Reebok did the same thing. So I think Nike's beauty is there hasn't been a peak trend because they're effectively paying a lot of money to help craft it even if they're not the leaders all the time. So I think that's what we will see, but again I think at the end of the day, this is a very, very large business. I mean multiples higher on a revenue basis than other competitors. And so figuring out how high is high from that business perspective, I think will be important and will be interesting.

And let's not ignore the fact that this is not-- the wholesale conversation is fascinating on both sides of the spectrum. It's fascinating on the Nike side of the conversation because they have so much wholesale, and now they're effectively moving away on the startup side. People took that same message.

And that was the digitally native story. That was the perceived DTC story of let's just start by not having wholesale. And that has now been proved to be the wrong model as well. And so I think from that perspective, I'm less concerned about Nike demand. I think the question will be what does that parlay into profits?

- Certainly. Two part question here and then we got to let you go, Simeon. First, have you seen the movie? Have you seen Air? Do we need to go see it?

SIMEON SIEGEL: No. Not yet. We've been passed over breaks right now, but dying to. I'll get there.

- OK. Done deal.

SIMEON SIEGEL: ? How about you guys?

- We'll put that on the Google calendar.

JULIE HYMAN: Not yet.

- Secondly here, when you think about the other sneaker companies that have said, running is resilient, especially in a pre recessionary environment and consumers trying to get their hands around costs for everything. From what they're wearing to up top to on their feet. For Nike, does that same resiliency hold true? It is a company, that you've said, is competing with itself and some part of the businesses might be hamstringing other parts because of the differing release schedules that they have.

SIMEON SIEGEL: It's an excellent question. I think, if you think about discretionary brands, they're generally smaller than staple brands. So need based purchases can be larger than want base purchases. And I think the reason is because of replenishment. The running is resilient also recalls the fact that you wear your shoes.

And so I think a big part of this is simply the question of the Holy Grail is creating a discretionary product that's also a replenishment item. Because at the end of the day, if you're walking on these or you're playing in these or whatever it is that you're wearing through these shoes, you're talking about your closet full of the New York studios that have unworn shoes.

But when we think generally about the volume that Nike sells, these are products people are wearing through and have to come back. And so I think that that's this interesting dynamic as well where as long as you are discretionary with replenishment, and you have the marketing dollars behind it, you create a story that people feel compelled to keep coming back to. And I think that's been effectively the magic of Nike.

JULIE HYMAN: Well, we'll see. And once we all see the movie, 1 we think it's peak--

SIMEON SIEGEL: Let's see it.

JULIE HYMAN: We'll make our assessment, and we'll have you back and talk about it. BMO Capital managing director Simeon Siegel. Thanks, Jimmy Simeon, good to see you.