Inflation is often a drag on equities, but it can really highlight the vulnerabilities of select consumer discretionary stocks. After all, if prices rise too quickly, shoppers respond by altering their spending habits, and many of those changes involve non-essential spending.
Then there's the other kind of inflation. That is the form companies deal with themselves. It's measured by the Producer Price Index (PPI), which showed potentially alarming signs for companies like Nike (NKE +0.88%) in May. Last month, the PPI surged 6.5% year over year, signaling potentially worrisome signs for input-cost-sensitive corporations such as Nike.
Nike stock is beset by tariffs and rising producer prices. Image source: Getty Images.
The May PPI reading arrived with shares of the athletic apparel giant mired in a bear market. Nike stock is off nearly 28% this year, and as of June 11, it resides some 43% below its 52-week high. Investors are right to be leery of any stock sporting those bearish percentages, and that caution should be amplified with Nike because there's no telling when producer prices will trend in the company's favor.
Nike margins under duress
One need not be a professional economist to understand why high input costs are drags on Nike. It's all about margins. The more it costs the company to produce sneakers, shirts, and other athletic gear, the more it needs to pass some of those costs on to consumers. If shoppers don't bite, margins languish.
So now Nike is on a six-quarter skid of declining gross margins. Yes, some of the margin erosion due to higher input costs is attributable to the war in Iran. Plastic and rubber, which are crucial to Nike supply chains, have been disrupted by the closure of the Strait of Hormuz.
However, the conflict in the Middle East isn't the only headwind Nike stock is contending with now. Don't forget about U.S. tariffs, which have been punitive to this stock. New U.S. trade levies are a $1.5 billion, or 320-basis-point, problem for Nike because the company relies heavily on Indonesia and Vietnam as production hubs.
NYSE: NKE
Key Data Points
Including Nike, some of the largest consumer discretionary companies source goods from those Southeast Asian nations. That's a risky gambit at a time when the U.S. is proposing new tariffs on several countries in the region, including Indonesia and Vietnam. Should those levies be imposed, it could be problematic for Nike, as Vietnam and Indonesia together account for 79% of Nike's footwear production.
Are there reasons to "just do it"?
These days, it sure feels as though some so-called experts are always talking about asymmetric stocks or those names with greater reward than risk profiles. Asymmetry may be in the eye of the beholder, but amid input cost and tariff strife, it's hard to make that call with Nike.
Investors looking for positives can find them in a 3.6% dividend yield, $7 billion in cash, and free cash flow of nearly $3.3 billion per year.
However, those are known variables, implying that investors are more alarmed by Nike's margin struggles than the positives entice them. Better days may lie ahead for the stock, but prospective shareholders are right to be cautious.
