Monday, January 19, 2015

How Nike, Inc. Just Sprinted Past Expectations

If you've ever thought Nike (NYSE: NKE  ) couldn't possibly keep growing as a $70 billion company, think again. Nike stock rose more than 7% in after-hours trading after the company announced that fiscal first-quarter 2015 revenue increased 15% year over year, to $8.0 billion.

That translated to a 27% jump in diluted net earnings per share, to $1.09, helped in part by a 3% reduction in shares outstanding after Nike repurchased another $819 million in stock during the quarter. Analysts, on average, were only expecting earnings of $0.88 per share on sales of $7.83 billion. Nike also said worldwide futures orders are up 11%, or 14% when you exclude the negative effect of currency changes. Inventories as of the end of August also rose in tandem, up 14%.

What drove that impressive performance? I recently suggested some things I'd be watching closely going into the report; so let's see what Nike had to say.

On SG&A, gross margin
First, I wanted to keep an eye on Nike's selling, general, and administrative expenses, especially as it continued to plow money into "demand creation" investments to take advantage of enthusiasm surrounding the World Cup. Sure enough, Nike's SG&A increased 21%, to $2.5 billion, including a 23% bump in demand creation, to $897 million.

However, that's also lower than the 30% increase in demand creation investments that management forecast during last quarter's call. Nike is methodical in its investments, and consistently boasts returns on invested capital north of 20%; so any cash put here will almost certainly prove money well spent.

I also wanted to watch Nike's gross margin, which can serve as evidence of its ability to use innovative products and strong brands to command higher prices. Sure enough, gross margin increased 170 basis points during the same year-ago period, 46.6%, driven once again by a shift to a higher-margin product mix, higher average prices, and continued strength in Nike's high-margin direct-to-consumer, or DTC, business.

Key growth drivers
DTC, in particular, continued to perform admirably. According to management in the follow-up conference call, overall DTC revenue growth accelerated to 30%. Nike's recent investments to streamline its e-commerce platform also continued to bear fruit, with Nike.com sales growth accelerating to 70%.

Driving the top line in a broader sense, Nike says, was "strong demand" for Nike brand products. Nike brand revenue rose 15%, to $7.4 billion, on growth in every product type, geography, and key category except Action Sports and Golf. Within that, Nike brand footwear -- its largest and most profitable business -- grew 18%, to $4.7 billion, apparel grew 11%, to $2.24 billion, and equipment grew 5%, to $454 million. We also shouldn't forget Converse: Revenue increased 16% on a currency neutral basis, to $575 million. This is not too shabby considering Nike bought Converse in 2003 for just $305 million.

Geographic expansion
Nike's strength is also geographically broad based: Revenue growth in all three of Nike's largest geographies accelerated during the quarter, including 12% growth in North America and, excluding currencies, 25% growth in Western Europe, and 20% in Greater China. The latter is very encouraging given the sheer size of, and past sluggish growth in, the Chinese market.

Management also elaborated that China's strength was aided by 30% growth in the region's DTC stores, and said that growth was even better at China DTC stores that have already undergone Nike's ongoing business reset in the region. Nike should be able to continue turning its China business around as it resets more stores and sharpens its product assortment to better meet the needs of Chinese consumers. For now, that lends credence to management's assertion that China is still poised to achieve sustained double-digit growth over the long term.

Apple Watch revealed: The real winner is inside
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