Nike working through ‘massive inventory problem,’ analyst says

Stifel Managing Director Jim Duffy joins Yahoo Finance Live to discuss Nike earnings, the footwear manufacturing company’s massive inventory problem, supply chain costs, consumer demand, and the outlook for the future of Nike.

Video transcript

- Also, everyone, Nike, whose Q3 earnings, they came out yesterday. And they boasted stronger-than-expected revenue. But shares of the footwear giant on the decline this morning.

Joining us to dive deeper is Jim Duffy, Stifel managing director in the consumer and retail sector. Jim, I want to get your broad read here, but perhaps you can zero in on the margins here for Nike and the fact that even I, as many other consumers, buyers of their products, perhaps, were really keen to some of these massive discounts that were coming and had taken place in this most recent quarter and how that ultimately impacted them.

JIM DUFFY: Sure. Good morning, Brad. Good morning, Julie. Thanks for having me.

So Nike has had a massive inventory problem. And they're working through that. Most importantly for the quarter, they made very good progress. That came at the expense of margins. Margins were a little bit light in the quarter, about 30 basis points. The guidance for the fiscal fourth quarter implied the full-year margin guide towards the lower end of their prior range.

The good news, however, is they are making good progress working through the inventories. Stifel's view here is that the reason to own this stock is for earnings power in fiscal '24 plus. To the extent that they can work through that inventory situation, get in a clean position into fiscal '24, we think there's a lot of margin recapture opportunity. Effectively, they've got about 350 basis points of supply chain costs and promotion, which can be a recapture opportunity in fiscal '24 plus. So that's really where we're focused.

- And, Jim, to work down that inventory, as Brad alluded to, they are going to continue to have to do some discounting. Do we have a good feel for outside of the core product how much discounting, how much of their merchandise is discounting as they try to work down that inventory? In other words, before we get to '24 and that uptick in profitability, we're going to have a little bit of a compression here in those margins.

JIM DUFFY: True. But you've got one quarter left. Remember, Nike's on a May fiscal year and so soon to be rounding the corner into fiscal '24.

Julie, let me frame it this way. So, indeed, promotion did benefit the sales rate in the quarter. We saw North America and EMEA both grow at better than 25% rates.

But encouraging to us, the unit growth was up 10%. But they also saw growth in ASP. So going along with that promotion is full price volume, which is driving the sales growth. So a lot of good indicators on brand vitality.

- There's lots of other stuff to ask about Nike specifically, including China. But I do want to broaden it out for just a second here because of this discounting. If a brand like Nike, which I think has such high brand value, brand recognition, et cetera, is doing this discounting, what's the read-through for the rest of retail, and particularly athletic, apparel, and footwear?

JIM DUFFY: It's a great question, Julie. Given Nike's scale, I often say when Nike gets a cold, the rest of the industry gets the flu. So Nike promoting, moving through this inventory has put pressure on the rest of the industry. And you've seen a promotional backdrop across the footwear and apparel landscape, but predominantly the apparel landscape, where Nike's inventory challenges were more exaggerated.

We view the report yesterday and their commentary about inventory control by the end of the fiscal year to be a healthy indicator for the industry as a whole. Nike getting clean on inventory is going to mean a less promotional backdrop. And that should benefit all players.

- One thing that we've heard from the CEOs of Brooks Running, as well as New Balance's CEO as well, is that running is recession resistant, Jim. And for Nike, they talked about on the call, them saying, again, running is at the heart of Nike, basketball being the soul. But for running and the recession resistance that these brands have all talked about, is there a clear categorical winner within this footwear industry for running as we look at the consumer and try to figure out where they may be looking still for discounts, for sales, even as Nike is trying to hold prices at 65% of their inventory being sold at full price?

JIM DUFFY: Yeah, we're actually seeing quite strong pricing trends in the running category. A couple of brands that have been gaining share and we're recommending both stocks, On Running, who reported yesterday, had 92% growth in their fiscal fourth quarter. They got into low 60s growth in their fiscal first quarter, very strong brand momentum there. Their premium-priced brand have been raising the pricing envelope for all brands in the category.

We're also recommending Deckers Outdoors, which owns the HOKA brand. HOKA also is seeing better than 50% growth rates. So a lot of strong trends in that running category. You are seeing some share shifts within the category. Some of the legacy brands are advocating share to HOKA and on. And Nike continues to make forward progress in running and so gaining share relative to the market.

- Yeah, it's amazing how we've seen On and HOKA just explode in popularity over the last couple of years. Jim, finally, did want to turn it to China and where we did see Nike make some progress. What do you think specifically in that region does Nike look like in the coming year?

JIM DUFFY: Yeah, you bet. So Stifel has a consultant that we've been working with in China to give us perspective on the sportswear market. We've been hosting quarterly conference calls with this consultant.

December 8 was the change of policy in China. We had a massive COVID outbreak in December that carried into January. Nike spoke to December trends being down year-to-year, a rebound in January inflecting to growth. And then, importantly, in February, they saw acceleration on that, despite what was more difficult compares with the timing of Lunar New Year a year ago.

So the market is moving in the right direction. And we're optimistic about what a recovery in China can mean for Nike and for other brands. Specific to Nike, we estimate that peak to trough, the earnings hit from a fall-off in the China business was $0.50 to the earnings power. And that's the recapture opportunity as that business comes back.

- We'll be watching it. Jim, thanks for the intel. Jim Duffy, Stifel managing director, appreciate your time this morning.