If you were lucky enough to own a piece of Nike (NKE 0.19%) prior to Thursday's close, congratulations are in order. Shares of the athletic apparel company popped following the release of its fiscal 2024 first-quarter numbers and encouraging expectations for the quarter now underway.
Specifically, per-share earnings of $0.94 were up slightly year over year, and they easily topped the analyst consensus estimate of $0.75 per share. Moreover, management believes profit margins will not only widen going forward, but its beleaguered business in China is positioned for a recovery.
And maybe that's exactly what's in store.
There are, however, three details buried in last quarter's results that I simply can't ignore. They suggest Nike may be facing stronger headwinds than the earnings call's rhetoric suggests. Here's a closer look.
1. Suddenly struggling where it matters the most
Yes, Nike's revenue in and around China was measurably up in the three months ended Aug. 31. Taking the impact of currency volatility out of the equation, Nike's Greater China division reported 12% year-over-year sales growth.
Do take that growth with a grain of salt, though, as the bar was set rather low. A year earlier, Nike's business in Greater China was down 13% year over year thanks to heavy-handed COVID-19 lockdowns. It remains to be seen whether this pace of progress is actually the new normal or just a restoration of what was lost.
Perhaps the more troubling geographical data from Nike's fiscal first-quarter report, however, is where it didn't do well. That's in North America. Despite these consumers mostly shrugging off inflation -- U.S. retail sales were up in June, July, and August -- Nike's North American revenue slipped 1% year over year.
One poor quarter doesn't necessarily point to an extended trend. Long-lived trends, however, do start with that first small step. It matters simply because North America is Nike's single-biggest market, accounting for over 40% of its business.
2. That's some expensive (and lower-margin) sales growth
Nike mustered a modest 2% improvement in overall sales last quarter. But the company had to spend a great deal of money on "demand creation" to make it happen. All told, the quarter's demand creation outlays (advertising, marketing, promotions, etc.) of $1.07 billion were up 13% year over year.
Connect the dots. Nike had to push very hard for relatively little sales growth, and even then, pre-tax income still fell 10% year over year. One has to wonder how long the brand will be forced to spend this heavily to generate anemic growth.
So, how did the company manage to post any per-share profit growth at all? It bought back a bunch of stock in the meantime, for starters, making its per-share metrics look better. The bulk of the help, however, came from a sharp reduction in income tax expenses ... from $360 million in the year-ago period to only $198 million this quarter.
The only problem is these aren't reliable bottom-line benefits from one quarter to the next.
3. Inventory levels are still too high
Last but not least, while Nike's management team accurately pointed out the company's recent inventory bloat is being dialed back, it's still above historical levels.
As with any other business, inventory is an asset on retailers' balance sheets. Unlike most other businesses, though, inventory can also be a liability to retailers too if that merchandise is at the wrong place at the wrong time.
Inventory ultimately represents an investment of capital, and it can lose value over time, especially for apparel retailers. That's why companies like Nike take inventory management very seriously, walking a fine line between too much unmarketable merchandise and not enough size, color, and style assortment.
Anyone following Nike's story since the pandemic probably knows it's been grappling with high inventory levels for the past couple of years with the problem coming to a head late last year. As planned, it's been clearing out this glut of goods since then. The value of on-hand merchandise contracted from $9.66 billion as of the end of Aug. 2022 to $8.70 billion a year later, a 10% decline.
Take a closer look at the bigger picture, though. Inventory levels are actually up a bit from the previous quarter's figure of $8.45 billion. They're also still uncharacteristically high compared to sales.
Data by YCharts.
It's not necessarily the end of the world. Most retailers are building up inventory levels right now in front of the busy holiday shopping season. Nike is no exception.
Still, Nike's merchandise level remains bloated by its own long-term standards. It might take a couple more quarters of above-average markdowns to shed the rest of this inventory swell, which could be cannibalizing sales of higher-margin merchandise in the meantime.
Think carefully before stepping into Nike stock
With all that said, don't misread the message. Nike still has its bullish points too. Chief among them is the sheer marketability of its brand name. The Nike swoosh logo is one of the world's most recognized, and the company dominates the athletic footwear and apparel market.
However, if you need the stock to perform well in the immediate future, that may not be in the cards. Management still has a couple of things to figure out, and it's trying to so in an economic environment that's less than ideal. It's an especially challenging environment for consumer-facing companies like Nike selling premium products at premium prices.
Bottom line? There's no need to sell the stock if you already own it, particularly given how shares have been beaten down this year. If you were considering taking on a new position in Nike, though, you might want to remain on the sidelines a little longer and see how it handles these challenges. There may be better options out there in the meantime.
