Investors were optimistic heading into Nike's (NYSE:NKE) earnings report this week and had pushed the stock up by 30% in the three months prior to the Thursday report. There were good reasons for this cheerfulness. After all, many retailers, including those ithin Nike's sales network, announced surprisingly strong customer traffic trends ahead of the holiday shopping season. The hope was that this rebound would speed Nike's turnaround in a U.S. market that's been weak for over a year.
Nike's fiscal second-quarter earnings report didn't deliver on that expectation. But the footwear giant did edge past management's top- and bottom-line forecasts to keep the business on track to meet full-year targets.
Let's take a closer look at the results.
The U.S. market is still weak
Nike gets more than half of its revenue from countries outside the United States, yet its home market is still its single biggest one and responsible for most of its earnings. Given improving recent results from retailers like Foot Locker, investors had hoped to see evidence of a building turnaround that would improve on the prior quarter's 3% sales decline and flat earnings.
Instead, the U.S market took another small step backward. Sales in Nike's North American segment dropped 5% even as segment profits dove 14%. In a conference call with analysts, executives said the U.S. market is still being held back by aggressive retailer promotions, which contributed to Nike's worsening gross profit margin. On the bright side, that weakness is being offset by strong demand in the e-commerce channel. And the success of recent product launches implies that the path back to sustainable growth runs right through innovative footwear and apparel releases.
Meanwhile, international markets outperformed expectations, with the Europe, Middle East, and Africa segment expanding by 14% in the quarter and Greater China spiking 15% higher. The China growth story is especially good news for Nike, since executives believe the addressable market there will be many multiples of the U.S. market over time. Sales in the China geography occur disproportionately through Nike's direct channels, too, which should deliver higher profit margins compared to the warehouse business.
The solid international results allowed Nike to modestly beat its own broad targets for the quarter. Overall sales grew by 3% to improve on the prior quarter's 2% uptick. Gross profit margin fell by 1.2 percentage points to beat the 1.8-percentage-point decline that executives had predicted.
Unfortunately, Nike's operating results didn't confirm an upcoming end to the stubborn contraction in the U.S. market. Management's comments were also cautious on this point. Chief Financial Officer Andy Campion only went so far as saying that executives see the segment "beginning to stabilize" soon. Investors were probably hoping for a more concrete prediction, and so the stock dipped immediately following the earnings announcement.
However, Nike confirmed its full-year sales and profit outlook and is on pace for modest growth in fiscal 2018 despite the weakness in the U.S. That's a far better result than rivals like Under Amour can claim.
In the meantime, the company is leaning on new product releases as its best shot at turning the business back toward accelerating growth. "Over the next several months," Campion told investors, "Nike will launch and scale more innovation than at any other time in our history."
This packed product pipeline should stall the market decline that Nike endured over the first half of its fiscal year. But investors will have to wait at least until the second-half results start rolling in for hard evidence that the U.S. business has stabilized.