Nike (NKE 0.23%) has long been associated with a winning attitude. And the stock, which has increased 217% over the past five years, has easily outperformed the S&P 500.
However, I think investors would benefit from understanding the bear case for the business right now. This is often an uncomfortable exercise, particularly for a popular name like Nike. But it's important to see both sides of the argument in order to become better and more informed investors.
Let's discuss three reasons that you might consider selling your Nike shares.
Image source: Getty Images.
1. Weakness in China
For many American consumer brands, China, with its massive population and expanding middle class, is a major growth driver. This is definitely true for Nike. During fiscal 2021, China represented 18.6% of overall sales, a figure that has steadily been rising.
But in the most recent quarter, revenue in the Greater China region decreased 20% compared to the prior-year period. The disappointing results in the country can be attributed to pandemic-related store closures, as well as lost production and lower available inventory. Additionally, consumer backlash against Nike -- in regards to concerns voiced by CEO John Donahoe earlier this year about cotton production in the Xinjiang region -- could result in shoppers favoring domestic brands.
The important question to ask is whether the weak numbers from China are temporary or not. I don't have the answer. "We expect to see sequential improvement from here, beginning in the third quarter," CFO Matt Friend said about China on the Q2 2022 earnings call.
Investors must pay attention to this going forward.
2. Changing retail landscape
One of Nike's key competitive strengths is its booming digital business, which is a vital aspect of the company's Consumer Direct Acceleration initiative to boost innovation and speed to market. In the latest quarter, digital sales jumped 12% year-over-year and now account for 25% of total revenue. And there are an impressive 79 million members in the Nike ecosystem.
But this shift hasn't come without meaningful change to the company's distribution strategy. In North America, the business has reduced the number of wholesale accounts by 50% over the past four years. While I think most investors would agree that being extremely selective is the right move, there's always the risk that Nike goes too far and completely alienates physical retail in favor of e-commerce. Striking the right balance between wholesale and direct-to-consumer, and not sacrificing incremental sales, won't be easy.
To Nike's credit, the business recently announced a new partnership with Dick's Sporting Goods (NYSE: DKS) that will connect its rewards programs with the thriving retailer's. The tie-up will allow shoppers to receive exclusive offers, products, and experiences. Nike is making a bet that not all brick-and-mortar retail is bad, and that consumers will still demand some in-person shopping.
Having a sizable store footprint was beneficial to Nike in the past, but it now has the potential to become a hindrance. How Nike continues to adapt to the changing consumer landscape, one in which a seamless omnichannel shopping experience is table stakes, will be critical to its long-term success.
3. Potential for more pandemic disruptions
Although tightening its footprint and leaning into digital will help, Nike is still exposed to the pandemic's unpredictable disruptions. Compared to Lululemon (NASDAQ: LULU), a smaller, faster-growing rival that only pushes merchandise via its website and its 552 company-owned stores, Nike is adversely impacted by store closures.
Lululemon generates a much higher proportion of sales (40%) online and in North America (85%), allowing it to mitigate possible pandemic risks by having greater control over its supply chain. On the other hand, because 61% of Nike's business is outside its home continent, it is significantly affected by supply chain disruptions, as we've seen in the past couple quarterly financial results.
I hope investors are now armed with the crucial information needed to round out their knowledge of the sports apparel juggernaut that is Nike. While the business certainly has some immediate challenges it has to navigate, if history is any guide, Nike will continue to do well over the long term. Going forward, keep an eye on the weakness in China, the changing retail landscape, and the ongoing pandemic's impacts on the company's performance.
