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Welcome to the Supernatural Stocks Podcast, hosted by The Finance Ghost on Moneyweb—your weekly resource for valuable insights in the world of investing and trading.
Nike’s investor relations site touts, “Nike Inc. is a growth company”—a statement that is enticing but challenging to validate. The reality depicted by the share price presents a stark contrast, showing a five-year compound annual growth rate (CAGR) of -5.3%, which effectively signifies a downturn.
Read: Nike to cease operations of its virtual sneaker label RTFKT under new CEO
This year, Nike’s stock has seen a sharp decline of 26.5%. If you made an investment decision, you may now be experiencing some regret.
The decline can be attributed to several factors, mainly stemming from overly optimistic expectations. While Nike is undeniably a leading global brand—from prominent retail stores in your vicinity to numerous knock-offs spotted in places like Istanbul recently—the impressive roster of athlete endorsements and a noteworthy sports legacy don’t necessarily equate to market success.
Despite its widespread appeal, a consumer in the middle-income bracket may think twice before opting for Nike’s higher-priced merchandise over its rivals. Personally, after buying a pair of Nikes last year to assess their quality, I found them no better than other well-respected brands.
The cost is primarily for the brand itself. This approach can thrive in luxury segments but presents risks in more mainstream markets.
If Nike’s brand is its most valuable asset, how does its strength really measure up? Herein lies the issue, as Nike appears to have misaligned with reality.
Is the brand robust enough to eliminate wholesalers like Foot Locker, banking on customer loyalty for direct purchases rather than retail variety?
Nike initially believed this strategy would succeed, leveraging the pandemic and the growth of e-commerce to reduce inventory and store variety at places like Foot Locker. For a while, this appeared effective, with dedicated fans turning to Nike’s app for their sneaker requisites.
However, as Foot Locker sought to stock up on brands eager to collaborate instead of compete, the dynamics began to change.
Nike has recently lost ground in pivotal product categories like running shoes, where consumers typically prefer to try items before purchasing.
This strategy has proven detrimental for both Nike and Foot Locker. In the past five years, Nike’s share price has dropped by 23%, while Foot Locker’s has experienced a significant dip of 44%. The only winners in this scenario have been consumers, benefiting from increased competition among previous partners leading to lower prices, albeit making shopping more complicated.
This predicament, amplified by supply chain issues and rising interest rates, has created a challenging situation for Nike—exacerbated by its pricing and distribution strategies. A crucial lesson here is determining whether the strength of a consumer brand is more reliant on distribution channels or brand appeal; it seems that distribution plays a more significant role.
What is Nike’s current standing?
Nike appears to be reconsidering its approach, as indicated by the uptick in promotional sales. If the brand genuinely holds strong, why is there such a large portion of discounted products in its offerings? The potency of a brand and pricing strategy is best reflected by the volume of sales made at full price.
This is where significant profit margins are generated. Promotions should primarily serve to move outdated stock. An over-reliance on discounts suggests weak demand at regular prices and points to a misguided strategy.
Over time, this could notably undermine brand credibility and create an expectation among consumers to wait for discounts instead of purchasing at full price, complicating recovery efforts.
Read: Apple CEO Tim Cook’s other role: Assisting Nike’s turnaround
In contrast, look at Lululemon’s savvy approach, where I established a long position this year due to recent stock weakness. Lululemon strategically employs Black Friday to clear old inventory while maintaining a fresh assortment, ensuring optimal price points without the need for discounts.
This strategy allows them to unlock working capital while still encouraging customers to purchase at full price—further emphasizing their brand’s strength. This is precisely why I prefer holding shares in Lululemon instead of Nike; I saw potential in one brand while opting out of the other.
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Can new leadership revive Nike?
Elliott Hill, Nike’s new CEO, is not new to the company, having dedicated 32 years to Nike before retiring in 2020. He returned just two months ago to address the strategic mistakes of previous leadership.
During the latest earnings conference, Hill outlined his top priorities.
A noteworthy remark from him was that Nike has veered away from its fundamental passion for sports.
With his extensive experience at Nike, he truly understands the brand’s essence. Going forward, the emphasis will be on sports, suggesting a pivot in product offerings from lifestyle-focused items. The brand narrative will likely refocus on athleticism, which is a wise strategy leveraging Nike’s advantage in athlete endorsements—this is the company’s unique competitive edge!
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A key aspect of their strategic change is the realization that an overfocus on Nike Digital has negatively impacted the brand. Moving forward, they will place significant emphasis on wholesale channels, aligning with consumer shopping habits instead of forcing online shopping exclusively.
This is a promising development for retailers like Foot Locker and Dick’s Sporting Goods, suggesting that a strategic recovery move for Nike might entail investing in one or both of these retailers.
Above all, regaining traction in full-price sales is critical. Presently, Nike’s digital platforms showcase an unacceptable split of 50% full-price to promotional sales for a brand that prides itself on being premium.
With a constant currency revenue decline of 9% this quarter and gross margins shrinking by 100 basis points to 43.6% due to promotions, significant challenges lie ahead. In contrast, Lululemon maintains a gross margin of 57%, illustrating the expectation from a premium brand.
Is progress on the horizon?
The lackluster performance during a year highlighted by the Olympics—the zenith of sports—underlines how far off course Nike has gone. Hill appears to begin with a strong vision.
However, this journey resembles more of a marathon than a sprint.
Nike’s current valuation is at a Price/Earnings multiple of 22x, aligning with several companies on the JSE. For further details, tune into last week’s discussion on P/E multiples and those in the over-20x range among top-quality firms on the JSE.
If Hill can reignite the passion within Nike, it may emerge as a noteworthy stock to keep an eye on by 2025.
For now, both Nike and Foot Locker remain on my radar. I’m contemplating investments in both, but I wish to witness signs of their share prices stabilizing and beginning to rise before proceeding, especially in light of the current hawkish stance from the Fed.
Prices could always decline further, and with certain stocks, it’s often advisable to wait for signs of momentum shifting—a valuable insight learned from seasoned traders!
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