Nike Falls After Earnings: Should You Buy?

Source: NIke.

Nike (NYSE: NKE  ) was falling by more than 3% on Friday as investors reacted with negativity to the company's latest earnings report. Nike is facing some difficulties in China, and competition from high-growth player Under Armour (NYSE: UA  ) is a relevant risk to watch. However, the long-term fundamentals are as strong as ever: Should you buy the dip in Nike?

The numbers
Overall performance was actually quite solid during the quarter ended on Feb. 28. Sales increased by 13% to almost $7 billion versus an average estimate of $6.8 billion by Wall Street analysts, and revenues in big markets such as North America and Europe were particularly strong, with increases of 12% in North America, 22% in Western Europe, and 17% in Central and Eastern Europe.

Currency headwinds affected the company in emerging markets, though, where revenues grew by 8% in U.S. dollars and by a much stronger 19% in local currencies. The same goes for Japan, with sales excluding currency fluctuations growing by 10%, but revenues in U.S. dollars falling by 9% due to the depreciation of the yen during the period.

China is a huge market in terms of growth opportunities, and the company has been facing some difficulties in the country lately. Sales in China grew 9% in U.S. dollars and 7% when excluding currency changes. This is not particularly exciting for a powerful global consumer brand such as Nike, especially in comparison to the much stronger performance it is reporting in more mature markets like North America and Europe.

Future orders were quite strong overall, with an increase of 12% in U.S. dollars and 14% higher when excluding currency fluctuations. However, future orders in Greater China were a big disappointment, falling by 1% in U.S. dollars and declining 3% in local currency.

Gross margins increased by 40 basis points to 44.5% of sales, as higher prices and the positive impact from growing direct sales more than compensated for higher input expenses and the negative impact from currency fluctuations.

Demand creation expense rose by 18% during the quarter, as Nike increases its marketing and product presentation expenses in preparation for the Football World Cup in Brazil. This generated an increase of 16% in selling and administrative expenses during the period.

Earnings per share came in at $0.76, better than the $0.73 per share forecast on average by Wall Street analysts.

Reasons for concern
CFO Don Blair said during the earnings conference call that the company expects to face significant currency headwinds in the coming months, and revenues are forecast to increase at a high-single-digit rate in the fourth quarter of fiscal 2014. This is lower than the growth rates implied in future orders, which is mostly due to the timing of shipments at the beginning and end of the quarter as well as lower levels of at-once and closeout sales.

As long as slower-than-expected growth is due to currency headwinds and timing differences, this is not much of a problem from a long-term point of view, but these kinds of issues can sometimes generate doubt among investors.

China is a particularly relevant reason for concern; management attributed the decline in future orders in the country to "planned changes in our seasonal product flow," and the company seems quite optimistic about the prospects for a turnaround in the medium term:

We still have work to do in China, in our China Reset, but we feel great about our progress. These efforts are improving our business today and, importantly, they set a strong foundation for our long-term profitable growth in China, and we continue to see tremendous growth opportunity in this key geography.

Still, both investors and analysts have valid reasons to closely monitor performance in this crucial market over the coming quarters.

From a competitive point of view, Nike seems to be performing quite well. Growth in Europe is probably indicating that the company continues gaining share versus big rivals such as Adidas and Puma in big categories like soccer.

On the other hand, Under Armour is firing on all cylinders and rapidly expanding in different product categories lately. With revenues of only $683 million in the last quarter, Under Armour is less than 10% the size of Nike, but the company generated an explosive sales increase of more than 35% during the fourth quarter of 2013.

The threat from Under Armour is no reason to panic at this stage, as Nike continues performing strongly on a global basis, but it's certainly not a competitor to ignore in the medium term, either.

Bottom line
Nike is an undisputed industry leader with an enormously valuable brand power and generating solid performance on a global basis. Weakness in China and growing competition from Under Armour are risks to watch, but the fundamental story is still intact. If you are thinking about buying the dip in Nike, just do it. 

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