Nike (NKE -0.83%) may be best known for its athletic apparel and brand endorsements, but the company's latest acquisition may signal how it plans to race past the competition. Over the last year Nike has faced a number of pandemic-fueled problems including factory shutdowns and supply chain disruptions. As a result, the stock has returned a mundane 6.75% over the last 12 months compared to the S&P 500 return of 27%. However, Wall Street is optimistic about 2022 as analysts believe the company has been able to sidestep its operational road bumps by doubling down on digital transformation.
The COVID-19 pandemic has caused a number of economic and operational disruptions for businesses of all sizes. Nike has battled factory closures in Vietnam and Indonesia, as well as rising shipping container costs and congested ports. As a result, the company has faced production problems and its transit times doubled from 40 days to 80 days.
Not surprisingly, Wall Street analysts and investors have kept a keen eye on Nike's financial results as it works through these operational challenges. For the fiscal quarter ended Nov. 30, 2021, Nike reported total revenue of $11.4 billion, up 1% year over year and narrowly beating analyst expectations of $11.3 billion.
Although a 1% year-over-year increase in revenue may not excite investors, a deeper look into the financials highlights some interesting insight into where the growth is coming from and the investments that the company is making.
The road to digital transformation
Nike has made great strides in its effort to embrace digital transformation. The company cut ties with a number of brick-and-mortar retail partners and is instead focusing on capturing more sales through its direct-to-consumer (DTC) channel, Nike Direct. Nike Direct represents digital channels as well as Nike-owned stores. There are indications that this strategy is working as the Nike Direct segment generated $4.7 billion in revenue for the fiscal quarter ended Nov. 30, 2021. This represented roughly 41% of total revenue in the quarter and a 9% year-over-year increase.
Adding to its success in digital outlets, Nike's brand digital sales increased 12% year over year led by 40% year-over-year growth in North America. The focus on digital is reaping benefits in the form of increased margins and profits for the company. For the fiscal quarter ended Nov. 30, 2021, Nike increased gross margin by 280 basis points to 45.9%. Management attributed the margin expansion to growth in the Nike Direct segment. Moreover, although revenue in the fiscal quarter only increased by 1%, Nike handily topped Wall Street earnings per share expectations reporting $0.83 per share compared to analyst estimates of $0.63. By cutting out the middleman in the form of third-party retailers and focusing on its own DTC channels, Nike has been able to increase its margins and profitability profile.
Nike is embracing a shift away from traditional retail outlets and accelerating toward a digital-first platform. As the company looks to move beyond selling in physical settings, it's become clear that Nike has its eyes set on another component of digital transformation: the metaverse. In early December, Nike announced that it was acquiring RTFKT (pronounced "artifact"), a virtual sneaker and crypto-collectibles business.
Next stop? The metaverse
The acquisition of RTFKT signals what Nike's ambitions to further expand the digital side of its business may be. The addition of RTFKT will allow Nike to capitalize on the rising interest of non-fungible tokens, or NFTs. Morgan Stanley estimates that the luxury digital-hybrid collectibles market could be a $25 billion segment of the larger $300 billion NFT space by 2030.
Additionally, in early November Nike filed a number of trademark applications indicating that it intends to create and monetize virtual branded sneakers and apparel. RTFKT was launched in 2020 and specializes in the creation of non-fungible tokens (NFTs) of sneakers and other collectibles. The rationale behind the acquisition may be that Nike plans to leverage the platform as it moves into selling NFTs of its sneakers and apparel.
Around the same time as the acquisition, Nike also announced that it partnered with gaming company Roblox, which launched a virtual world called "Nikeland" in which users can decorate their avatars with Nike-branded gear.
Despite near-term supply chain headwinds, Guggenheim analyst Robert Drbul issued a note to investors on Jan. 3 pegging Nike as his best idea for 2022. The analyst believes Nike will be able to increase its market share as it continues to scale online and innovate with new footwear and apparel products both in the physical world and digital arena.
Nike was not immune to pandemic-induced challenges such as supply chain hiccups, increased shipping costs, and factory closures. Nonetheless, the company has done a nice job side-stepping some of these issues by focusing on its direct-to-consumer and digital outlets. As a result, Nike has managed to increase revenue, expand margins, and generate higher profits. Long-term investors may want to consider a position in Nike as the company's digital ambitions could unlock lucrative opportunities as it looks to become more than an industry leader in physical apparel.