There was plenty of excitement among investors after Nike (NKE 1.36%) delivered a better-than-expected earnings report for its latest quarter ended in November (for Nike, its fiscal year Q2). The leading shoe and apparel stock leaped higher by a double-digit percentage in the final days of the calendar year on optimism that the company will be able to make its way past stubborn inflation and mounting economic headwinds going into 2023. 

But I don't think Nike is quite out of the woods yet. While active wear is on trend these days and not going away anytime soon, a high valuation, excess inventory, and sluggish profit growth is curbing my enthusiasm for this particular apparel business.

An asterisk on Nike's impressive growth

Nike put up impressive sales numbers in its fiscal Q2, beating Wall Street expectations and delivering a 17% year-over-year increase to $13.3 billion. When excluding currency exchange rates, sales would have grown 27% year over year (more on that in a moment).

A footnote is needed on this revenue performance muscle flex. As discussed last quarter, Nike (as well as other apparel companies) have been dealing with a sudden influx of inventory. As global supply chains loosen up from the pandemic, Nike finally found itself with a lot of extra merchandise on hand, and it entered a period of heavy discounting to help rightsize it. Sure, consumer demand was there to help soak up all that inventory. Nike has also, no doubt, benefited from brand troubles over at rival Adidas.

But don't discount the effect of discounting on Nike's revenue surge. The dramatic effect of this excess inventory sell-through shows up when charting the value of Nike's shoes and threads in stock over the past year.

NKE Revenue (TTM) Chart

Data by YCharts.

The good news is that Nike appears to be putting some distance between itself and its peak inventory problem at the end of Q1 a few months ago. But there's still more apparel-discounting work to be done through the holiday shopping season.

Selling more product at a lower price means lower profitability. Indeed, in spite of the 17% increase in sales last quarter, gross profit margin fell three percentage points year over year to just 42.9%. Some operating expense controls helped, but ultimately net income was flat year over year. Earnings per share merely power walked 2% higher thanks to share repurchases.

The company still faces some challenges

With Nike and much of the apparel market still selling merchandise at lowered prices right now, I expect profit margins to remain under pressure for at least another quarter, maybe two. But that's not the only challenge Nike is battling. 

A strong U.S. dollar is stifling a lot of multinational companies, Nike included. As the Federal Reserve has hiked rates, the value of the dollar has enjoyed a record run-up against other currencies. The effect is lower-value revenue and lower profits when Nike converts that international sale back into dollars for financial reporting purposes and to pay expenses. This effect will also likely last into 2023 and muffle Nike's progress.

For the full fiscal year, Nike is expecting year-over-year sales growth in the mid-single-digit percentage range. That could mean earnings per share struggle to gain momentum for the next couple of quarters.

And I don't believe the market is fully discounting this issue. Even after tumbling nearly 35% from all-time highs reached in late 2021, the shares trade for 33 times trailing-12-month earnings per share, and 30 times one-year-forward earnings per share.

Even if Nike can reaccelerate earnings growth to 25% over the next two years, then settle into a mid- to high-single-digit percentage growth rate after that, Nike stock merely looks fairly valued at this juncture (using a discounted cash flow valuation method). And I believe an earnings growth rate of over 20% for the next two years is a big ask from giant Nike.

Of course, I could be woefully wrong about Nike's valuation and growth prospects. Nevertheless, the top shoe company hasn't quite made its way out of the woods yet, so I'd rather have my money on a smaller, faster-growing athletic apparel brand like Lululemon Athletica at the moment.