It's barely October, but Nike (NKE 0.95%) is already playing the Grinch this year.
Shares of the sportswear giant tumbled 13% last Friday after it forecast a rough holiday season, and cast a shadow over the broader retail industry. At a market cap of more than $130 billion, Nike is one of the world's most valuable consumer brands, and it's worth paying attention to what it has to say about the consumer environment because consumer spending in the U.S. represents 70% of gross domestic product.
The company issued a number of warnings for the holiday season that are likely to weigh just as much on its peers, suggesting a poor close to the year for the entire retail sector that could hurt the stock market much more broadly.
Image source: Nike.
The stronger dollar is killing us
Like most global companies, Nike is getting crushed by the stronger dollar. The U.S. dollar index is up 19% over the last year, meaning the currency is worth 19% more than it was a year. That effectively makes international sales for companies like Nike worth 19% less.
What's worse is that the dollar could continue to strengthen since U.S. interest rates are expected to rise, Europe is facing turmoil over the war in Ukraine, energy costs have spiked, and the British pound crashed recently.
In the latest quarter, Nike's revenue would have increased 10% if the value of a dollar had remained the same, but instead revenue rose just 4%. Management said on its earnings call that it now expects a $900 million effect on operating income from the stronger dollar in its current fiscal year. Many of its peers are likely to face the same pressure.
Don't count on China to save it
At one point not long ago, China was Nike's fastest-growing market, and an emblem of its long-term growth opportunity. No longer.
COVID-19 lockdowns have made China Nike's biggest weakness, with sales in the region down 16% in the recent quarter and profits off by 23%. Management said it was taking a more cautious approach in the region due to the risk of COVID disruptions.
China has long been a prized growth market for American multinational brands like Starbucks, Disney, and Coca-Cola, but China is likely to be a headwind in the coming months as the uncertainty around virus disruptions continues.
Get ready for markdowns
Though Nike's revenue was up just 4% in the quarter, inventories rose 44%, tracking with much of the retail sector, which had ramped up production to compensate for earlier supply chain delays and to get product into stores ahead of the holiday season.
Nike said it was taking steps to clear inventory, discounting to move merchandise off the shelves faster. It said its gross margins would fall 350 to 400 basis points in the current quarter, citing a "largely promotional marketplace."
Chief financial officer Matt Friend also said Nike expects promotions in the industry to continue through at least the calendar year.
While such markdowns will be good for holiday shoppers, it's bad news for retailers and the brands that supply them. Gross margins are likely to shrink substantially in the fourth quarter, given elevated inventory levels across the industry.
Don't forget the macroeconomic uncertainty
Nike cited macroeconomic uncertainty several times on the earnings call, and the situation could be even more strained heading into the holiday season. The Federal Reserve is expected to raise interest rates another 75 basis points in early November, year-over-year inflation remains above 8%, labor shortages continue to plague much of the country, and an energy crisis is brewing in Europe heading into the winter.
Those headlines tend to weigh on consumer confidence, and make holiday demand hard to predict for retailers and consumer-facing brands like Nike.
The company has been tested several times before by economic disruptions, and it's emerged victorious each time. Investors should be confident that it can overcome the challenges in front of it.
While high-quality stocks will still deliver strong returns over the long term, investors should be prepared for an ugly holiday season, especially in the consumer and retail sectors.
