It's been a roller-coaster ride for Nike (NKE -1.26%) shares over the past couple of years. From its peak in November 2021 to its 52-week low in September 2022, the stock dropped more than 50%. But since then, it's up about 44%. During the most recent fiscal quarter (Q3 2022, ended Feb. 28), Nike was able to beat Wall Street expectations on both revenue and diluted earnings per share (EPS).
However, there are some glaring issues hurting the business that investors need to know. Here are three reasons you might want to consider selling Nike's stock, which is down about 4% since that latest earnings report.
Margins are under pressure
In the latest quarter, revenue rose 14% year over year to $12.4 billion. This is wonderful growth, but it comes with a caveat. Diluted EPS of $0.79 during fell 9% in the same period. This means that Nike's operating margin compressed meaningfully in the quarter to 11.4%
Supply chain challenges forced Nike to load up on inventory, which many apparel companies did. Now the business needs to find ways to get rid of this merchandise. The inventory balance (as of Feb. 28) of $8.9 billion was 16% higher than what it was a year ago, outpacing sales growth. To its credit, Nike was able to decrease its inventory level on a sequential basis. But higher markdowns and promotional activity pressured the gross margin, which was 43.3% in the quarter, down from 46.6% in Q3 2022.
Management expects inventory challenges to continue in the near term, with the gross margin for the full fiscal year down 2.5 percentage points. "This reflects ongoing and accelerated actions to reduce inventory by year-end," CFO Matt Friend mentioned on the earnings call.
Struggles in Greater China
North America, which accounted for 40% of Nike's overall revenue in the most recent fiscal quarter, has always been the company's most important region. But over the past several years, Greater China has been a major growth engine. Thanks to having the world's biggest middle class, successfully tapping the Asian country is unsurprisingly a gold mine for Western consumer brands. The coronavirus pandemic threw a curveball for Nike, with strict lockdown measures, followed by a spike in cases, being a huge burden in the country.
Sales in Greater China, which represented 16% of company revenue, declined 8% in the quarter, making this the sixth consecutive period of year-over-year decreases. Sales in Greater China underperformed what Wall Street was expecting by $100 million.
Nonetheless, the leadership team continues to wait for a rebound in China. "Long term, we are confident that the fundamentals of growth for Nike in China [remain] strong," Friend said. Investors might have confidence in management's upbeat comments, but it could be a bumpy ride before things stabilize in that part of world.
An unattractive valuation
As of this writing, Nike's stock is trading at a trailing price-to-earnings (P/E) ratio of just under 35, which is significantly cheaper than its past five-year average of 47. On a forward basis, shares are selling at a P/E of 37 thanks to Nike's downbeat earnings guidance. Compared to the S&P 500's trailing and forward P/Es of under 18, Nike looks awfully expensive right now.
Furthermore, consider the company's younger rival, Lululemon Athletica. The premium athleisure pioneer has increased revenue at a much faster clip than Nike has in recent years. Plus, Lululemon's gross and operating margins are consistently higher than Nike's. Even with this outperformance, Lululemon trades at a trailing P/E of 51, as a result of its latest blowout quarter -- but on a forward basis, its P/E of 32 is cheaper than Nike's.
All of this is to say that investors who were looking to add Nike to their portfolios might want to hold off until there are clear signs of improvements in key areas. And the challenges might even be enough of a reason to sell.
