Let's Put Nike's Bad Quarter in Context

In this Market Foolery podcast segment, host Chris Hill and Motley Fool Asset Management's Bill Barker parse the latest numbers from athletic-gear and sneaker giant Nike, which have to be viewed in context. In the first quarter of its fiscal 2018, profits fell 24%, and gross margin is shrinking. But the retailers that sell the products of Nike and its rivals are in an even worse jam, and at least it's getting its direct-to-consumer e-commerce channel up to speed. So what could the company do next to respond to the ongoing difficult conditions in its niche? And is it at any risk of getting tangled up in the NCAA bribery scandal?

A full transcript follows the video.

This video was recorded on Sept. 27, 2017.

Chris Hill: Let's get to Nike. First-quarter profits fell 24%. Gross margins are going in the wrong direction. And I know they're trying to build out that direct-to-consumer channel, but it seems like for them and others, it's not moving quickly enough. So I'm curious, when you looked at Nike's latest report, what stood out to you?

Bill Barker: Well, it's doing a better job than a lot of the other companies in this space, which have been obliterated in terms of their stock value, much more so than Nike has over the last year, say, when you look at things like Finish Line, the suppliers, places where people are getting their Nike apparel and shoes when they're not getting it direct. And that business is under a great deal of pressure. It's under a great deal of promotional pressure, which is increasing. So Nike is wise and has done a pretty good job of getting the direct-to-consumer operations up and growing much faster than the rest of the space. But when you've got as much pressure on your main distribution channel as they do have, they had approximately the same level of sales as the quarter 12 months ago, but the profits were way down. Operating profits were down about 10% on the same level of sales. And a few more, go down the net income sheet, the taxes were heavier than they were last year, there were some other things moving, earnings per share were down for more than 10%.

Hill: When you think about the promotional aspect of Nike and how much money they spend on marketing, it really does seem like a delicate balance that, in large part, over the last 10 or 20 years or so, they have pulled off nicely. And by that I mean, when you think about opportunities around big events, whether it's the Olympics or the World Cup, or it was quadrennial events as opposed to, every year in America, there's the World Series, the Super Bowl, the NBA Finals. I think they're playing hockey this year, although I'm not sure. I think the NHL is still doing that. We take every other year off. But it really does seem like, given --

Barker: Why do you have to troll NHL fans like that?

Hill: Is that not the case? Are they not taking every other year off?

Barker: I'm just asking. On their behalf. I've never met any of them personally, but I understand that they exist and they should be treated equally.

Hill: They should be, but I think most of them live in Canada.

Barker: You're from Canada.

Hill: No, I'm from Maine. It's like South Canada.

Barker: All right, if you say so. Did you play a lot of hockey growing up?

Hill: None whatsoever. I can't ice skate.

Barker: Wow. No wonder you're down here in Virginia now.

Hill: Yeah, it's one of the reasons the Maine tourism board asked me to leave.

Barker: Get teased a lot?

Hill: No. Well, not for that.

Barker: "Look at Chris! He can't skate!"

Hill: For other reasons I got teased, but not for that.

Barker: Kid would skate by and beat you up with their sticks and stuff.

Hill: No. I wouldn't be near the rinks or the frozen ponds.

Barker: I just assumed there was ice everywhere.

Hill: A lot of times, yeah. But it does seem like that balancing act, there's more pressure around that over the last year or two, specifically because of the ripple effect of Sports Authority going out of business. You mentioned Finish Line. You might as well throw Dick's Sporting Goods in there as well. Foot Locker -- the three of them not really taking advantage of Sports Authority no longer being in existence. And I'm wondering if we're going to see Nike pull back on some of that marketing spend over the next year or so, because, again, they've pulled it off in the past, but when you see gross margins getting compressed the way they have been lately, then I think there are absolutely people at the highest levels of Nike and probably Under Armour as well saying, "You know what? I love -- insert name of person who heads up marketing -- but we have to cut that budget back."

Barker: Well, Nike is operating from a much stronger space in that equation than Under Armour. They are, along with just being bigger and more established, and much better known in footwear. They're also just much better operators than Under Armour. Which is done -- let's give them a great deal of credit for how fast they have grown their company. But Under Armour has not focused on the bottom line to the extent that Nike has. They just don't have the same margin performance that Nike has. So Nike can give up a little bit of margin. It's not something you want to see as a shareholder, it's not something that management is going to be happy about, having to promote the way they have. But they are very strong players, in terms of sourcing and how they operate their business in a way the competition isn't. Now, I don't know how much they can afford to throw at everybody, and I can see in the headlines some trouble for others in the space regarding the way they've thrown their money around colleges, and that's something I'm sure Nike is watching closely and hoping doesn't visit them. It would be rather surprising if this story is as small as it is today.

Hill: You're talking about Adidas and four assistant basketball coaches being accused of funneling money from Adidas representatives to high school athletes.

Barker: Yeah. Adidas has been doing very well in this country, and there's a little bit of a relationship between these two things, but they have now surpassed the Jordan brand, this was getting a lot of press yesterday, that Adidas is now some 13% of the footwear market here. Nike, on the bright side -- good news out of China, which is, as I understand it, a reasonably sized market.

Hill: Pretty big.

Barker: So that's good. And North America is the problem, and that is their largest location for sales, and it's the one you want to have the largest sales in. But that's not growing, as we see from everybody else in the space.

Hill: Shares of Nike are close to a two-year low. When you look at where the stock is right now, do you think this represents a screaming buy or at least a good entry point for people who are looking to pick up shares of the dominant player in this space?

Barker: Not a screaming buy. There's just too much competition, too much trouble in retail generally, to get super excited right now. Their price-to-earnings is about 21, five-year average is 26, so a little bit cheaper. But keep in mind that they have taken a year of not growing, whereas over the five-year average that I'm referring to, where Nike has been priced at 26 times earnings on the average, most of those five years, they were showing pretty good growth. And now we're not only looking at flat sales, but decreasing profits. So a 21 multiple, that's roughly what the market is as well. 

Nike is a great company and they've had a great past, and they're in a very relevant industry, but retail is just not that exciting.