Nike (NKE -0.74%) is having a rough start to 2022. The stock is down 21% through the first two months, and the company is hampered with output disruptions due to the pandemic and its myriad consequences.
Fortunately, consumer demand for its products is resilient. Nike is selling nearly everything it can produce and get onto shelves. Let's look closer at the business and determine if investors should buy the dip in the stock.
Image source: Getty Images.
Nike is aiming to make more direct sales to consumers
Notably, there are two ways Nike sells its products: direct to consumers (DTC) through its website and brick-and-mortar locations, and secondly through wholesale partners like Macy's. Of course, Nike's DTC sales are more profitable primarily because it can sell more products at full price.
Wholesalers ask for discounts and attractive terms to secure better profit margins. What's more, at wholesalers Nike's products are displayed alongside those of competitors, giving consumers an option to choose the lower-priced product. It's no surprise that management has implemented a strategy of accelerating its DTC business.
The timing could not be better, considering the widespread shortages of supplies. If Nike has limited inventory and must choose whether to keep it for sale through its channels vs. through wholesalers, it is choosing the former. Already, the strategy is paying off. In the six months ended Nov. 30, Nike's gross profit margin expanded by 230 basis points to 46.2%. If it finishes the rest of the year at that margin, it will match the highest in the last decade.
Meanwhile, revenue has grown by 8% in the six months ended Nov. 30, so Nike is not sacrificing sales to achieve higher profit margins. That's an excellent sign for shareholders as typically it slows sales growth when a business aims to expand profit margins. From a consumer perspective, the more places you see a company's products, the more opportunity there is to buy. Nike has done an excellent job promoting its website and app and attracting potential customers to buy directly.
Not just any brand can pull this move off. Nike is executing a strategy that highlights its strong customer loyalty and brand awareness. Indeed, sales have increased from $23 billion in 2012 to $44 billion in 2021. Strategically, the move increases the company's negotiating power with wholesalers: improve your terms or we will reduce supplies to your stores.
Nike's stock sell-off is a buying opportunity
Nike will continue to be challenged by the pandemic-caused supply disruptions in the near term. Longer term, it is in an excellent position to capitalize as consumers continue to move their shopping online, where the company can capture sales directly at higher margins.
Fortunately for potential investors, it looks like the market has not yet priced in Nike's excellent prospects. The stock is trading at price-to-earnings and price-to-free-cash-flow ratios of about 33 and 35, respectively. Those are right around the average over the past five years. So to answer the question I posed in the headline: yes, Nike's sell-off is a buying opportunity for long-term investors.
