Nike’s European and Chinese rejigs pay off

The Nike group is enjoying a rebound in Western Europe and in China, two regions where it reorganized its business in the last two years. They both contributed to the ample gains achieved by the Nike brand for the three months until the end of November, in sales as well as in gross profit margins.

The entire group's sales from continuing operations jumped by 8 percent to $6,431 million, which was a rise of 9 percent in constant currencies. The Nike brand's sales improved by 7 percent to $6,070 million, again up by 9 percent without exchange rate changes. As part of adjustments made in the reporting methods, these Nike brand numbers include the results of Nike Golf and Hurley, the action sports brand.

The rise in the Nike brand's turnover was spread across all categories and regional units. Sales in the group's own retail operations improved by 19 percent for the quarter, with a comparable store sales increase of 10 percent and a robust rise in online sales, up by 33 percent. They were pushed up by the start of online sales in Japan and in Brazil but still made up less than 15 percent of Nike's own retail sales – prompting the company to predict much more expansion in the quarters to come.

The revenues of the Converse brand expanded by 14 percent to $360 million in dollars and by 11 percent in constant currencies. The rise was fueled by sales increases in countries where Converse has taken over its distribution not so long ago, particularly the U.K. and China – and more remarkably, in North America.

The Nike brand's sales soared by 18 percent to $1,074 million in Western Europe, which was an increase of 15 percent in constant currencies. The rise was driven by footwear, with underlying sales increasing by 23 percent, compared with a rise of 3 percent for apparel. Under the split adopted for this fiscal year, the regional breakdown for the Nike brand includes Nike Golf and Hurley but not licensing revenues.

The Western European rebound was driven by the U.K, Northern Europe and the German-speaking countries. The group said sales soared by at least 20 percent in the U.K. and the German-speaking countries. The entire region's sales rise was bolstered by performance categories such as running and basketball, which delivered double-digit sales expansion. The same applies for the group's Young Athletes business.

Own retail sales in this area jumped at double-digit rate and the Nike group pointed to productive partnerships with retailers, such as the House of Hoops concept implemented with Foot Locker in the U.K. and shop-in-shops at Karstadt in Germany and Futbolmania in Spain – replicating some aspects of the “category offense” strategy that has propelled the Nike brand's growth in North America in the last years, in spite of its already voracious market share in the region.

Earnings before interest and tax (Ebit) in Western Europe increased by 12 percent to $123 million for the quarter. The rise would have been sharper without a charge relating to an adverse legal ruling related to the bankruptcy of an unspecified former retail customer, which was the most significant factor behind one-off expenses of $13 million for the quarter.

Sales were up as well in Central and Eastern Europe, which achieved an underlying increase of 18 percent for the quarter to $295 million. The company's managers gushed about a remarkable performance in Russia. Ebit for the region was up by 30 percent to $48 million.

The trend was equally encouraging in China, where the Nike brand's sales returned to an expansion mode: After four quarters of declines in constant currencies, Nike's Chinese sales advanced by 8 percent to $629 million in the quarter, and by 5 percent in constant currencies, driven by running, basketball, football and sportswear.

As part of its efforts to get over its weakness in China, Nike has been segmenting and differentiating its points of distribution. It has also been sharpening its merchandising strategy, trialing four new concepts in its own stores and with retail partners. These included new fixtures and more refined merchandising. And the company is also fine-tuning its operations to make sure products hit the right store at the right time.

All of this paid off with comparable store sales increase of more than 20 percent in Nike's own stores, for the third quarter in a row, and improvements in the partner stores that have been upgraded. These stores have been enjoying higher turnover and better sell-through than average. The company added that it had also been aided by overall improvements in the inventory situation in China. Ebit in the region inflated by 5 percent to $197 million, as the impact of growing sales was mitigated by investments in the group's retail business.

However, orders from China showed a paltry increase of just 1 percent at the end of the quarter. The company was quick to reiterate that the road to recovery in the region may be a little bumpy, because its improved retail strategy has caused some cancellations, returns and discounts, which lead to disparities between orders and actual sales increases. But the group's managers said they were building sustainable and profitable growth in China. They still expect roughly stable sales for the full fiscal year, with a single-digit increase in the third quarter and stable or slightly declining sales in the last quarter.

North America continued to yield a robust sales rise for the Nike brand, up by 9 percent to $2,801 million. This includes a 12 percent increase in sales from Nike's own retail operations, driven by 7 percent comparable store sales expansion. Ebit for North America advanced by 15 percent to $649 million. While the group continues to expand its North American running and basketball business, its category offense strategies are also meant to pursue growth in the women's and Young Athletes categories, where Nike has spotted major opportunities.

The youth category yielded double-digit growth for the quarter and this expansion is expected to accelerate on the back of new retail concepts, like the Nike Fly Zone at Kids Foot Locker. Women are targeted in the Nike Training Club stores, where sales of women's products outpace those in other stores by strong double digits. Nike has therefore decided to expand the concept beyond the 20 stores it started in August, and to have more than 40 such Nike Training Clubs by the end of the fiscal year.

The Nike brand took a hit in Japan, where its sales shrank by 13 percent to $210 million, but that was entirely due to exchange rate swings – without them, Nike's Japanese sales would have increased by 9 percent. The same occurred on a smaller scale in emerging markets, where the Nike brand's sales were off by 4 percent to $1,030 million, but they increased by 3 percent in constant currencies. This somewhat disappointing performance was caused by logistical issues in Mexico, where Nike switched to a new third-party logistics provider in June. Shipments were delayed, causing a build-up in the local distribution center and shortage of products in the stores. Nike admitted that it would even take a few quarters to fully regain its Mexican business at retail and to sort out remaining inventory issues.

On the other hand, the Nike brand enjoyed double-digit growth in Brazil, its largest market in the Emerging Markets region. Ebit for the region dropped by 18 percent to $243 million, which the group blamed on exchange rate changes and increased marketing investments ahead of the World Cup, as well as the opening of new stores and the launch of Nike.com in Brazil.

The entire group's gross margin expanded by 1.4 percentage points to 43.9 percent, thanks to a judicious mix of factors: While product input costs decreased, the company was able to command higher average prices and its sales mix was more favorable, particularly because of higher own-retail sales. The mitigating factors included the higher cost of labor in product input costs and unfavorable exchange rates.

Another factor that weighed on profits is that selling and administrative expenses were up by 14 percent to nearly $2.1 billion. This was due to an increase of 13 percent in marketing expenses, as Nike geared up for the Winter Olympics and the football World Cup to be held next year.

The Nike brand's Ebit reached $845 million, up by just 2 percent, but it jumped by 10 percent to $100 million for Converse. The group's Ebit inched up to $725 million, an increase of just 2 percent. The company's net income landed at $537 million, which was just 3 percent more than the same period of the previous year for continuing operations.

For the first half of the fiscal year, the Nike group's turnover climbed to $13,402 million, which was an increase of 8 percent in dollars and in constant currencies. The Nike brand alone lifted its sales by 7 percent to $12,538 million, an increase of 8 percent in constant currencies, while Converse sales were up by 16 percent to $854 million, amounting to a rise of 14 percent without exchange rate changes.

The group's gross margin for the first six months of its financial year expanded by 1.4 percentage points to 44.5 percent, while Ebit reached $1,773 million, up by 18 percent. Net income from continuing operations rose by 19 percent to $1,317 million for the six months.

As the half-year came to an end, orders for Nike products to be delivered from December until April next year were up by 12 percent in dollars and by 13 percent in constant currencies. This included a rise of 10 percent in units and 3 percent in average selling prices. The rise in orders was propelled by football, sportswear, running, basketball and women's training.

Excluding exchange rates, the increase reached no less than 23 percent in Western Europe and 14 percent in Central and Eastern Europe. Orders advanced by 11 percent in North America and by 15 percent in emerging markets. However, they crawled up by just 1 percent in Japan and in China, for the reasons outlined above.

As the company gears up for the World Cup, Nike executives gushed about the launch of national team jerseys for Brazil and France – among a record of ten national teams to be outfitted by Nike at the World Cup in Brazil. The launch of the Brazil kit in Rio was accompanied by a full day of partying, as well as a Run Rio 10-kilometer event and a concert on the beach.

Made with Dri Fit technology, engineered mesh and laser cut ventilation, the jerseys are 16 percent lighter than those worn by Nike teams at the European football championships in 2012. They are made of recycled polyester, using the equivalent of 18 recycled water bottles in every kit. The eight other kits are to be revealed in the coming weeks.

The Nike group expects its sales to increase at a high single-digit to low double-digit rate for the third quarter, and at a low double-digit rate in the fourth quarter. For the full fiscal year, sales should grow at a high single-digit to low double-digit rate.

The positive factors that fueled the growth of the gross margin in the first half should still be felt in the second half, but the company also sees some adverse factors such as pressure from raw material costs and increased discounts to clear pockets of excess inventories – while pressure from labor costs and from exchange rates will continue.

The group therefore expects the gross margin to expand by about 25 basis points in both the third and the fourth quarters. For the full year, the gross margin should climb by about 75 basis points. Another factor to take into account is that marketing expenses are expected to inflate by more than 20 percent in the third quarter.

Nike is investing in manufacturing techniques to try and mitigate rising labor costs in the long term. The group has also taken measures to help increase the capacity of its manufacturing partners for fast-selling and relatively complicated technologies like Flyknit, as it continues to spread to more footwear categories.