The sports apparel industry is just the latest retailing niche to be disrupted as consumers shift their spending to online specialists. That move stopped Under Armour's (NYSE:UAA) (NYSE:UA) growth in its tracks last year and has also sent industry leader Nike (NYSE:NKE) scrambling for a fresh operating approach.
Judging by the stock price, investors aren't optimistic that the new strategy will yield quick results. Nike was the Dow's single worst performer last year and has trailed the market by a wide margin so far in 2017.
Let's look at whether or not that slump represents a buying opportunity for long-term investors.
Nike will be fine
On the plus side, Nike has several advantages that should help it outperform in this difficult selling environment. The retailer is a global enterprise, for one, with over 50% of sales generated from markets outside of the U.S. Under Armour, in contrast, counts 80% of its revenue as tied to the slumping U.S. geography.
Given the brutal slowdown in the U.S. retailing industry, Nike plans to lean heavily on those outside markets, especially China, for most of its sales growth over the coming quarters. That's the way things have played out so far in fiscal 2018 as international gains completely offset a declining U.S. segment.
Nike is also no slouch in the innovation department, with recent launches helping it capture market share in the coveted premium shoe segment on styles approaching $200 apiece. Dominating categories like that will make it easier for Nike to defend against value-based competition while holding its position at the high end of the market.
Yet rivals are ramping up their innovation spending, too. Under Armour recently touted a new massive footwear design center that management said shows a commitment to "developing best-in-class products." Of course, there's room for both companies to succeed in this arena, and the competition could actually spur stronger growth for the entire industry. However, that doesn't change the fact that Nike must keep leading the way in product development.
Its recent innovation wins weren't nearly enough to deliver earnings growth last quarter. Gross profit margin fell by nearly 2 full percentage points to 43.7% of sales. That miss contributed to a painful profit contraction as net income tumbled 24% even as the company benefited from a big drop in marketing expenses.
Investors can expect to see more profit struggles ahead as Nike aggressively shifts its focus in the U.S. market toward the direct-to-consumer business. Sales growth in that area won't be enough to fully offset declines in the traditional retailing segment for a while. The segment expanded by 11% last quarter, for example, yet overall revenue was flat.
The good news for investors is that Nike earns far more profit from each direct sale than it does for sales that occur through its warehouse channel. That's just one more good reason for CEO Mark Parker and his executive team to focus on building out the e-commerce segment today.
The case for waiting
Even with surging digital sales, the upcoming holiday shopping season threatens to be a rough one given that both Nike and Under Armour have posted falling sales and decreasing profitability in recent months. If you're a believer in Nike's rebound plan, then you might want to take advantage of the pessimism in the industry right now to buy one of the world's most valuable brands at a discount.
But I think it's more likely that shares will continue to underperform until Nike's results show an end to anemic customer traffic that has convinced retailers to slash prices in the U.S. market. Until that happens, investors won't have a good idea about how long it will take before the broader business can start expanding sales and profitability again.
Demitrios Kalogeropoulos owns shares of Nike, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool owns shares of and recommends Nike, Under Armour (A Shares), and Under Armour (C Shares). The Motley Fool has a disclosure policy.