The superficial logic makes enough sense: Nike (NKE -0.74%) is sitting on too much inventory, so shareholders should sell the stock before markdowns take their usual toll on margins and profitability.
Except, as many veteran investors can attest, a narrative like this one can sometimes take on a life of its own and ultimately do more damage than is merited. How troubling are Nike's inventory woes, really?
Same weakness, different reason
On the off chance you're reading this and aren't aware, Nike's shares shed 12.8% on Sept. 30 and are still down over 10% as of this writing, capping off a more than 50% slide from their Nov. 2021 peak.
The bulk of that price plunge was driven by a sales slowdown in China that could eventually be mirrored in other markets.
The latest piece of the sell-off, however, came in response to last week's release of the company's fiscal 2023 first-quarter numbers showing seemingly inflated inventory figures. Specifically, at the end of Nike's fiscal 2023 first quarter, it had nearly $9.7 billion worth of merchandise on its books, well up from the $6.7 billion it reported a year earlier. For perspective, that latest inventory tally represents 76% of the same quarter's revenue, giving the company the highest inventory-to-sales ratio it has seen in a long, long time.
Data source: Nike. Chart by author. Inventory and revenue figures are in millions of dollars.
There's no denying it: Like so many other retailers, Nike has a lot more merchandise on hand coming out of the pandemic than it normally would have.
There's more to the story, however.
A change in philosophy on supply and demand
Sure, between strained supply chains and wobbly economic conditions, Nike wasn't able to sell the amount of merchandise it was aiming to when it ordered all those goods. Some of its inventory is still marketable at full retail price in any season, while some of it will need to be marked down to sell.
There are two key realities regarding the matter that Wall Street's overlooking, however.
First, the company is deliberately purchasing goods earlier than it has in the past. It wasn't expecting to be sitting on $9.7 billion worth of inventory as of the end of last quarter, most likely. However, Nike has considered the supply chain disruptions that the pandemic and its ripple effects have wrought, and decided it never wants to be caught in a position again where it simply doesn't have enough goods to meet demand.
The transition to this new line of strategic thinking showed up in a big way in last quarter's numbers, although its inventory levels have actually been building since late last year.
Second, supply chains are really, really broken right now.
During the company's quarterly earnings call, Chief Financial Officer Mathew Friend explained, "[O]ur North America inventory grew 65% versus the prior year, with in-transit inventory growing approximately 85%. This reflects the combination of late delivery for the past two seasons, plus early holiday orders that are now set to arrive earlier than planned."
Translation: At the same time Nike was ensuring it had enough goods for the upcoming holiday shopping season, it was also receiving goods that were supposed to be delivered several months ago.
As was noted, some of this merchandise can be sold at full price. Markdowns on other portions of these goods, however, are expected to contribute to a 200-to-250 basis point reduction in the company's gross profit margins over the course of this year.
Two reasons Nike is in better shape than you think
So far, that's all bad news. But there's actually a glimmer of hope for investors.
One should take this outlook with a grain of salt as it comes from a member of Nike's management team who has a vested interest in conveying optimism. But during the call, Friend also said, "We expect that total inventory in North America peaked in Q1, and we anticipate seeing sequential improvement over the year as we rebalance supply and continue serving strong demand."
North America is Nike's biggest market in terms of revenue and earnings, typically accounting for about half of each.
Image source: Getty Images.
Also bear in mind Nike is still putting several technology initiatives in place, and those haven't had time to create measurably meaningful benefits in a normal, non-pandemic-impacted environment. The company's enterprise resource planning platform geared for its operation in China didn't go live until July, and a comparable tool for the North American market won't go live until 2024. In the meantime, look for Nike to fine-tune the use of a demand-inducing digital platform provided by Adobe that has only been up and running for a few months.
There's no way of gauging just how much these tools will help Nike rationalize its inventory levels, nor exactly when they'll make an impact for the better. They certainly can't hurt though, particularly in light of the fact over 40% of the athletic apparel company's revenue is driven in-house rather than via partner retailers. That means a big chunk of the company's destiny is in its own hands.
Don't overthink it
Last quarter was not the one Nike was hoping for, nor even the one the company was expecting just a few months prior. It will take time -- and markdowns -- for it to work through much of its existing inventory.
It's not something the company's ill-equipped to do, however, and it's likely to do so sooner and more efficiently than the stock's current price suggests. Indeed, the much bigger concern for shareholders and would-be shareholders is the specter of a recession that might prompt consumers to think twice before splurging on some new sneakers.
Even then, though, that prospect may already be over-reflected in the stock's halving since late last year. Nike is one of the world's premier brands, and it boasts a strong, loyal following. It has also navigated tougher challenges in the past. If you're truly a long-term investor, this pullback offers a great entry opportunity.
