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Here's My Top Stock to Buy in October

By Will Ebiefung – Oct 3, 2020 at 8:40AM

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Nike has turned the coronavirus pandemic into a massive opportunity to improve its business model.

The coronavirus pandemic has been a massive challenge for retailers in 2020, but the crisis has accelerated digital trends in consumer behavior that could benefit those willing to adapt. I think Nike (NKE -1.33%) will bounce back from the crisis stronger than ever because of its rapidly growing online business. Let's dig a little deeper to find out why this footwear company is poised for continued success. 

Pile of $100 bills

Image Source: Getty Images.

Transitioning to a digital business model

Nike was slammed by the coronavirus pandemic, which disrupted supply chains and closed down its retail outlets in the fiscal fourth-quarter -- sending revenue down 38% to $6.3 billion. But management used the crisis as an opportunity to accelerate the company's transition to a digital business model, which could improve margins and boost profitability over the long term. 

The company reported first-quarter revenue of $10.6 billion, only 1% below the prior-year period. And while retail sales volume continues to lag, online sales are powering growth in key regions like EMEA (Europe, Middle East, and Africa) and Greater China, which expanded by 5% and 6%, respectively. Nike's digital sales already represent over 30% of total sales, and could soon generate the majority of revenue if current trends persist. CEO John Donahoe expects the shift to continue, even after the pandemic is over.

Here's what he had to say at the company's first-quarter earnings call on Sept. 22:

The consumer today is digitally grounded and simply will not revert back. Our NIKE digital business is already meeting our mix goal of 30%, nearly three years ahead of schedule, and we will continue to grow from here.

A more streamlined and profitable Nike

Continued growth in Nike's online business could mean better margins and the potential for bigger profits. The company already enjoys a 10-point higher gross margin on digital sales versus wholesale, and management can boost digital margins further in two compelling ways: First, the company plans to place inventory closer to consumers to lower fulfillment costs. And second, it plans to leverage customer data to personalize product offerings to enable higher sales prices and lower discounts. 

Nike's gross profit margin jumped from 37.3% to 44.8% quarter-over-quarter as it adapted to a more digital business model. But the company's gross margin is still down around 90 basis points against the prior-year period because of markdowns and other challenges related to lower retail traffic. 

Nike is reducing its operating margins by slashing advertising expenses (focusing on a smaller number of more impactful campaigns), as well as layoffs to eliminate redundancies in the workforce. The company's "demand creation" expense (meaning advertising) fell 33% to $677 million, and its selling and administrative expense fell 11% to $2.97 billion in the first quarter. Operating expenses could fall further in the coming periods as employee terminations begin in October. 

It's not too late to hop on board 

Nike has turned the coronavirus crisis into an opportunity, and the market is taking note. The stock is up roughly 25% year to date, and it boasts a PE multiple around 73 -- significantly higher than the S&P 500's average of 29. But I think Nike stock is still a great buy, despite its lofty valuation, because it looks positioned to generate better-than-average bottom-line growth through its convincing digital transition. 

Will Ebiefung has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Nike. The Motley Fool has a disclosure policy.

Stocks Mentioned

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Nike
NKE
$109.88 (-1.33%) $-1.48

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