Nike addressing excess inventory; Q1 Ebit falls 13 percent

Nike, ever bullish on its digital approach, is facing an excess-inventory dilemma, contracting gross margins and persistent currency headwinds as it moves into the holiday season.

The scenario emerged as the group reported a 22 percent decline in Q1 net income to $1,468 million from $1,874 million for the period ended Aug. 31. Ebit fell 13 percent to $1,828 million from $2,106 million as total reported revenues rose 4 percent to $12,687 million from $12,248 million. Higher freight and logistics costs, unfavorable currency exchange rates and higher markdowns in its direct business contributed to a 220 basis point drop in gross margin to 44.3 percent. Demand creation expense rose 3 percent to $943 million from $918 million. Digital sales increased 23 percent that was fueled by double-digit gains in the EMEA, North America and APLA that realized higher traffic, conversion and growth in average order value (AOV). Converse sales rose 8 percent on a currency-neutral basis to $643 million from $629 million. 

Despite exceeding Wall Street’s expectations on its quarterly revenues and earnings per share in Q1, Nike’s stock price fell 2.24 percent in after-hours trading yesterday to a new 52-week low of $93.19 a share. In pre-market trading today, Nike shares were down more than 13.3 percent from yesterday’s closing price of $98.70. 

In detailing its results and current excess-inventory situation, Nike senior management told analysts that the company has not yet seen any signs of a consumer slowdown related to recessionary factors worldwide, as it realized double-digit retail sales growth in September. Still, the group is “taking a more measured approach” and tightening inventory buys around the globe, on the basis of risks that may materialize during the second half of its FY, when it anticipates a more modest growth rate. Promotional activity in North America, already on the rise, is expected to continue through the remainder of 2022. 

The company’s current pressing issue is liquidating excess inventory, which was partly created by late product deliveries of spring-, summer- and fall-season products. Total inventory increased 44 percent in Q1 to $9.7 billion, led by 65 percent growth in North America and an 85 percent increase in in-transit goods. Nike intends to accelerate the liquidation of approximately 10 percent of its total inventory, largely apparel in the North American market, as it introduces fresh products to consumers through its strategic partners and own direct channel. Gross margins are forecast to drop 350 to 400 basis points in Q2 through aggressive discounting of out-of-season products with higher markdowns in its own channels and in wholesale partners. Meanwhile, currency impact has accelerated considerably over the last three months, because of the strengthening U.S. dollar. Nike currently estimates that the full-year impact of foreign exchange on its reported revenues and Ebit will be about $4 billion and $900 million, respectively. 

“I think the distinction here that we’re trying to make is a distinction between footwear strength and seasonally appropriate product and innovation and late-arriving apparel that been impacted from the factory closures a year ago,” CFO Matthew Friend told analysts. “So, we’re really focused on trying to clear through that late off-season apparel inventory that we have predominantly in North America, but we do have a little bit of it in EMEA and APLA as well.”

Inventory levels are predicted to normalize by the end of the current quarter, on Nov. 30, paving the way for Nike to shift toward more full-priced offerings by the start of its Q3. 

Nike realized record results in EMEA during Q1, as total revenues rose 17 percent on a currency-neutral basis to $3,333 million from $3,307 million. Reported regional sales were up a mere 1 percent, because of currency impact. Regional footwear sales topped $2 billion, up 18 percent currency-neutral, and apparel sales were 15 percent higher on a currency-neutral basis at $1.15 billion. Ebit was up 11 percent on a reported basis, with broad-based growth and strong gross margin expansion during EMEA’s most profitable quarter ever.

Nike direct sales were 20 percent higher currency-neutral, and Nike digital sales increased 46 percent. September-to-date retail sales were described as being up double-digits, with strength in France, Germany, Italy and Spain offsetting some softness in the U.K. The company opened its first Nike Rise store in the EMEA in July in West London, after debuting the format earlier in China and Korea. Following Dick’s Sporting Goods in the U.S. and TopSport and Pou Sheng in China, Zalando and JD Sports have been added to the brand’s connected membership program in the EMEA. The model is said to give shoppers the benefit of Nike membership in these partner stores, which in turn accelerates in-store conversion rates and engagement.

Since FY19, EMEA gross margins have increased by more than 500 basis points, as Nike digital has expanded its penetration to 20 percent from 7 percent, nearly tripling its share of the region’s brand revenues. 

Elsewhere, Nike is taking a “cautious near-term approach” to Greater China, where Q1 revenues declined 13 percent currency-neutral at $1,656 million versus $1,982 million and fell 16 percent on a reported basis. Regional Ebit was down 23 percent on a reported basis, and direct sales were down 2 percent currency-neutral, as store operations and retail traffic continued to be impacted by Covid-related disruptions. However, the group reported that inventory management across the country is ahead of plan. Nike recently launched a localized app to serve Chinese customers and is encouraged by its strengthening demand among young and Gen Z consumers in the market. 

In its home North American market, Q1 revenues rose 13 percent to $5.51 billion, fueled by a 17 percent increase in footwear sales to $3.8 billion and a 5 percent improvement in apparel sales to $1.49 billion. But Nike saw shifting conditions in the market during the period, as earlier ordering by retailers prompted by consumer demand and less predictable delivery times led to higher inventory levels across all consumer goods.

APLA revenues grew 16 percent currency-neutral to $1,535 million from $1,465 million in Q1, as regional Ebit rose 4 percent on a reported basis. There was double-digit, currency-neutral sales growth in Southeast Asia, India and Korea, as direct sales jumped 30 percent on a currency-neutral basis.

Nike’s outlook for its full financial year calls for low double-digit, currency-neutral growth, with the H2 increase expected to moderate.

On the product front, management contends the brand’s flow in the months ahead will be a key differentiator for its business. It cited a new apparel innovation, NIKE Forward; the Air Max Scorpion; a refreshed signature basketball line; and new sportswear collaborations as some examples.