traditionally innovative_ the history of nike - market realist.pdf

8/10/2019 Traditionally Innovative_ The History Of NIKE - Market Realist.pdf

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Traditionally innovative: A must-know investors guide to NIKE (Part 1 of 22)

A legendary company with a tradition of fostering innovation

Nike is the name of the Greek goddess of victory. Its also an apt name for a company with a passion for athletic excellence

NIKE, Inc. (NKE) is the worlds largest seller of athletic footwear and apparel. The c ompany was originally founded as Blue

Ribbon Sports in 1964 by current Chairman, Philip Knight, and Bill Bowerman, a former track and field coach at the Univers

of Oregon.

NIKEs history of innovation started with the waffle trainer

NIKE, Inc. was incorporated in its present form in 1968, in Beaverton, Oregon. Over the years, the companys products hav

been the stuff of legend, achieving cult status. The companys known for introducing products that get sold out within minute

of hitting stores. NIKE filed as many as 540 patents in 2013 alone.

Bill Bowermans legacy at Nike is immeasurable, said Mark Parker, President and CEO of NIKE, Inc. The products he

designed and invented have powered Nikes ascent as the worlds leading sports brand, and his commitment to pushing the

Traditionall innovative: A must-know investors uide to NI

Traditionally Innovative: The History Of NIKEBy Phalguni Soni- Disclosure Dec 2, 2014 3:58 pm EST

Pr
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Knights ideas have been revolutionary and have transformed an entire industry. From new manufacturing strategies, to

endorsements of top athletes and sports marketing, hes a recognized industry leader.

ETF impact

NIKE, Inc. (NKE) had a market cap of $83.8 billion company as of November 25, 2014. It forms part of S&P 500 Index and t

more select, 30-stock Dow Jones Industrial Average. A number of exchange-traded funds have exposure to the stock

including the SPDR S&P 500 ETF (SPY), the SPDR Dow Jones Industrial Average ETF (DIA), the SPDR Consumer

Discretionary Select Sector ETF (XLY), and the Vanguard Dividend Appreciation ETF (VIG).

An investment opportunity?

NIKE has increased its dividends per share for 13 consecutive years. How is NIKE able to do this? In this key investors guid

to NIKE, youll read an overview of the company, including details of operations and an analysis of its financials. Youll also

read about its relative competitive position and the companys key strengths, weaknesses, opportunities, and threats. Well

cap the series with a relative valuation analysis versus its peers.
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Why NIKE is the #1 sports brand in the world

The sportswear equipment and apparel industry is highly competitive and includes many prominent players. NIKE, Inc. (NK

is the largest seller of athletic footwear and apparel in the world. It has a footprint in 190 countries. NIKE has sustained its

competitive edge by applying some effective strategies:

Focusing on innovation and the introduction of proprietary products NIKE AIR, Lunar, Shox, Free, Flywire, Dri-Fit, FlyKnit, NIKE+, and

NIKE Fuel

Building up a portfolio of globally recognized brands

Using targeted high-impact marketing at high-profile sporting events such as the soccer World Cup, the Rio Olympic Games, and the NF

Super Bowl

Making endorsement deals with high-profile athletes like Neymar, LeBron James, and Roger Federer

NIKE is a winner in the brand stakes

NIKE is the worlds number one sports brand.1Its brand value was estimated at $19 billion by Forbes magazine in 2014. Its

up from $15 billion in 2012 and $17.3 billion in 2013. Walt Disney Companys (DIS) ESPN was second with a brand value

estimated at $16.5 billion, followed by Germanys Adidas AG (ADDYY), the United Kingdoms Sky Sports and fast-growing

US brand, Under Armour Inc. (UA).

ETFs holding NIKE

The Vanguard Total Stock Market ETF (VTI) and the iShares Core S&P 500 ETF (IVV) have exposure to NIKE, Inc. (NKE).

Where NIKE Stands In The Brand StakesBy Phalguni Soni- Disclosure Dec 2, 2014 3:59 pm EST
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NIKEs brands

NIKE offloaded the Cole Haan and Umbro businesses, on February 1, 2013, and November 30, 2012, respectively. This wa

done so the company could better focus its resources on driving growth in its existing stable of brandsthe NIKE, Jordan,

Converse, and Hurley brands. The next part of this series will cover these.

1. The Forbes Fab 40: The Worlds Most Valuable Sports Brands 2014


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The NIKE brand

NIKEs brand products are available in eight main sporting categories:

Running

Soccer

Basketball includes Brand Jordan

Mens Training includes US football and baseball

Womens Training

Action Sports includes Hurley

Sportswear sports-inspired lifestyle products

Golf

NIKE also markets products under the NIKE brand focused on kids and other sports, including cricket, lacrosse, tennis,

volleyball, and wrestling, among others.

NIKEs line of performance equipment includes bags, socks, sport balls, eyewear, timepieces, digital devices, bats, gloves,

protective equipment, golf clubs, and other equipment designed for sports activities.

NIKEs brand stable includes Brand Jordan and Brand Hurley

As mentioned in Part 2 of this series, the NIKE brand is the most valuable sports brand in the world. Besides its well-known

namesake, NIKEs brand stable includes several other brands that were either developed organically or acquired:

Brand Jordan named after iconic basketball superstar Michael Jordan

Brand Converse its line of casual sneakers, apparel, and accessories, purchased in 2003

Brand Hurley targeted at action sports like surfing, skateboarding and youth customers

An Overview Of NIKEs Brand StableBy Phalguni Soni- Disclosure Dec 2, 2014 3:59 pm EST
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Who uses NIKEs products?

NIKE, Inc. (NKE) is the worlds leading sports footwear and apparel company. NIKEs high-performance athletic gear is

mostly targeted at professional athletes. NIKEs innovations, products, and services seek to develop athletic potential,

according to the company.

The company also focuses on women customers. In fact, the Womens Training segment is faster growing than the Mens

Training segment. With a view to ensuring future growth, young athletes are a big part of its sales strategies, especially in

categories such as soccer, basketball, and running. Young athletes will form NIKEs target market in the future. Well have

more on these opportunities and their potential later on in the series.

NIKE brands

NIKE purchased Converse in 2003. The brands product line looks at the premium target market. It includes casual appareland footwear products, which are sporty but not necessarily high performance. Brand Hurley caters primarily to action sport

such as surfing and skateboarding. Brand Jordan, named after basketball superstar Michael Jordan, is also a premium labe

brand targeted at athletes.

Aside from these, NIKEs come up with various product lines endorsed by athletes such as LeBron James. These lines are

high performance and targeted at athletes.

Digital sport

Digital has been the focus of NIKEs marketing efforts in recent years. The companys gone hi-tech with its push into digital

NIKEs Target Market Today And TomorrowBy Phalguni Soni- Disclosure Dec 2, 2014 3:59 pm EST
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sport and e-commerce. It introduced the Nike+ running sensor in collaboration with Apple Inc. (AAPL). Other products such

as the Nike FuelBand personalize the hi-tech experience for the customer. The FuelBand tracks the intensity of workouts an

even motivates the wearers, among its many uses. These products appeal to both athletes as well as non-athletes.

The push into digital gives the company the opportunity to engage directly with the customer. Digital initiatives are especially

appealing to younger customers. They also provide invaluable feedback to the company about the overall customer

experience.

The SPDR Consumer Discretionary Select Sector ETF (XLY), the iShares S&P 500 Growth (IVW), and the iShares Russell1000 Growth (IWF) have exposure to NIKE, Inc. (NKE).
http://marketrealist.com/quote-page/iwf/http://marketrealist.com/quote-page/nke/http://marketrealist.com/quote-page/xly/http://marketrealist.com/quote-page/ivw/http://marketrealist.com/quote-page/aapl/


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Analyzing NIKEs distribution channels and retail model

NIKE distributes its products through three major channels:

By selling products to wholesalers in the US and international markets

By direct-to-consumer (or DTC) sales, which include in line and factory retail outlets (see graph below) and e-commerce sales through

www.nike.com

Sales to global brand divisions

Retail partnerships

NIKE, Inc. (NKE) has also tried to create category-specific retail destinations by partnering with footwear retailers such

as Foot Locker, Inc. (FL), JD Sports, and Intersport.

NIKEs sales mix and retail slant

Sales to wholesalers are the largest revenue category. However, this categorys contribution in the sales mix contracted fro

83.3% in fiscal year 2012 to 79.2% of revenues in fiscal year 2014. DTC sales, on the other hand, increased from 16.2% to

20.3% over the same period. This is significantly lower than the ratio of DTC revenues for NIKEs rivals in the space. In the

most recent quarter, the respective ratios of DTC revenue to total revenue for Under Armour Inc. ( UA), VF Corporation (VFC

and Adidas AG (ADDYY) were 25.3%, 23%, and 25.4%.

NIKE is focusing on direct selling to the consumer with its DTC initiative. Comparing NIKEs distribution channels, direct sale

to the consumer provide higher margins than do sales to wholesalers. In fiscal year 2014, DTC revenues accounted for ~20

NIKEs Distribution Channels: How Products Reach CustomersBy Phalguni Soni- Disclosure Dec 2, 2014 3:59 pm EST
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of total NIKE Brand revenues as compared to 18% in fiscal year 2013. On a currency neutral basis, DTC revenues grew 22

in fiscal year 2014 and 30% in 1Q15, year-over-year.

The company is attempting to grow the DTC category to $8 billion in sales by fiscal year 2017, up from $5.3 billion in fiscal

year 2014. Thats an annual growth rate of 14.7%, compounded.

Read the key elements of its store and online strategies in the next part of this series.


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NIKEs retail click-meets-bricks marketplace strategy

NIKEs DTC (or direct-to-customer) approach is three-pronged:

NIKE brand and category experience stores

Online sales through its online portal www.nike.com

NIKE factory stores

Pricing power through the NIKE brand experience stores

The NIKE brand experience stores provide customers with the full bricks-and-mortar retail proposition. Premium stores that

offer the consumer the best brand experience, experience stores include NIKETOWNs, the largest stores in the fleet. Each

NIKETOWN features six or seven NIKE brand categories, providing the very best innovative product and services those

categories have to offer. This premium customer experience gives NIKE higher pricing latitude on the products offered.

For example, the NIKE Running Store in New York City caters to the complete needs of the runner, from compete to train, to

express, all in one place. Its a hub for both premium services and a premium experience.

The second goal is creating category experiences. Along with its wholesale partners, NIKE aims to create unique experienc

such as the House of Hoops for Basketball with Foot Locker, Inc. ( FL), or the NIKE Track Club for runners with Finish Line o

the Field House with Dicks Sporting Goods Store, Inc. (DKS). These product differentiation strategies allow for premium

pricing. They also benefit NIKEs wholesale partners by bringing them into the limelight.

Factory stores offer a premium value proposition, broaden NIKEs customer base

The Rationale Behind NIKEs Retail FocusBy Phalguni Soni- Disclosure Dec 2, 2014 4:00 pm EST
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NIKEs factory stores provide a premium product to consumers shopping for value. Due to the value proposition involved, th

tend to attract higher shopper volumes.

Online sales through www.nike.com

Online sales made up ~15% of total NIKE brand DTC revenues in fiscal year 2014, compared to ~12% in fiscal year 2013.

Online selling is one of key future growth drivers of NIKEs retail strategies. The category grew by 42% in fiscal year 2014,

and was up by 70% year-over-year in 1Q15.

Well look at other growth drivers in the next part of this series.

In comparison, Amazon.com, Inc. (AMZN), the worlds largest online retailer, grew sales by 20.4% year-over-year in its mos

recent quarter, ended September 30, 2015. Wal-Mart Stores, Inc. (WMT), the worlds largest retailer, grew global e-commer

sales by ~21% in the quarter ended October 31, 2014, on a constant currency basis.

The SPDR Consumer Discretionary Select Sector ETF (XLY) and the SPDR S&P 500 ETF (SPY) provide exposure to

Amazon and NIKE.
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NIKEs growth model

NIKE, Inc. (NKE) was incorporated as far back as 1968. Yet its grown strong over the past decade and positioned itself as

company poised for further growth. NIKE has grown its earnings per share (or EPS) at a compounded annual growth rate o

~13% over the fiscal years between 2004 and 2014. Its targeting revenues of $30 billion in fiscal year 2015 and $36 billion

fiscal year 2017, up from $27.8 billion in fiscal year 2014. Lets examine the key growth drivers that the companys banking

on.

Increasing focus on retail and creating a dynamic retail environment

Getting retail dynamics going is a big chunk of NIKEs growth strategy. Although sales to wholesalers accounted for about

79% of NIKEs global revenues in fiscal year 2014, the companys been trying to tilt the sales mix toward direct-to-customer

(or DTC) sales, which have comparatively higher margins. DTC sales include sales through company-owned retail outlets a

e-commerce sales through its portal, www.nike.com.

NIKE unleashes the power of digital

NIKEs digital initiative, NIKE+, has tens of millions of users. The company plans to grow that number to hundreds of millions

Its using digital to personalize its relationship with customers. Digital is also a great marketing tool for driving higher custom

Understanding The Catalysts Fueling NIKEs GrowthBy Phalguni Soni- Disclosure Dec 2, 2014 4:00 pm EST
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engagement. For example, the NIKE+ Training Club clocked ~17 million downloads by 1Q 2015.

NIKEs digital e-commerce thrust is vital. The company plans to grow online sales almost fourfoldfrom $540 million in fisca

year 2013, to $2 billion by 2017.

Innovation in product design, category leadership

NIKEs thrust has always been on providing customers with well-constructed, uniquely designed products. As explained

earlier, most products are leaders in the individual categories. The company invests extensively in R&D (research and

development) for new technologies and their applications for existing product lines, depending upon consumer preferences.

The proliferation of NIKE AIR, Lunar, Shox, Free, Flywire, Dri-Fit, FlyKnit, NIKE+, and NIKE Fuel technologies through

Running, Basketball, Mens Training, Womens Training, and Sportswear, among others, typifies the companys dedication

designing innovative products.

Premium services and tailored solutions for customers

NIKEs product portfolio features premium products that command higher prices. This enables the company to differentiate i

products in the marketplace and at the same time charge higher prices than the competition.

NIKEs also focused on providing a personalized customer experience. The NIKE Running Store in New York City caters to

the complete needs of the runner from compete to train to express, all in one place. It serves as a hub of a premium-level

services, as well as premium-level experiences.

ETFs holding Nike

The Vanguard Dividend Appreciation ETF (VIG), the SPDR Consumer Discretionary Select Sector ETF (XLY), the SPDR D

Jones Industrial Average ETF (DIA), and the SPDR S&P 500 ETF (SPY) have exposure to NIKE, Inc. (NKE).
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North America: NIKEs largest growth driver

Despite having operations in 190 countries across the world, North America continues to be the most important of NIKEs

growth drivers. North American sales make up about 44% of its total revenues worldwide. And, NIKEs projecting high single

digit top-line growth in North America through 2017.

A combination of product innovation and pricing power spearhead the companys efforts to stay ahead of the pack. Theres

also a large gap between NIKE, Inc. (NKE) and its nearest competitors, Under Armour Inc. (UA), VFC Corporation (VF),

Lululemon Athletica Inc. (LULU) and Adidas-owned (ADDYY) Reebok.

Emerging markets

NIKE believes Brazil and China (FXI), two key markets, are under-penetrated. Chinas growing middle class and the growin

sporting environment are important revenue opportunities. The company wants to improve its product mix and profitability inthe Chinese market to take advantage of the changing landscape.

Brazil already has a healthy sports culture, even apart from soccer. NIKE was a sponsor at the FIFA 2014 soccer World Cup

and is also a sponsor at Rios Olympic Games, slated for 2016. The company wants to use these opportunities to enhance

image not only in Brazil, but all over the world.

Parts 11 to 13 discuss how these opportunities are likely to pan out.

Womens Training: Growth to outpace overall company growth

NIKEs Growth Drivers In The US And OverseasBy Phalguni Soni- Disclosure Dec 2, 2014 4:00 pm EST
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NIKEs product range

These are NIKEs major product categories:

Apparel

Footwear

Equipment

Footwear ranks #1 among revenue earners for NIKE

NIKE is the number one brand for athletic footwear in the US. It leads the competition by a wide margin, always thinking in

terms of the separation it can create between the NIKE brand and rival footwear manufacturers.

Competitors Under Armour Inc. (UA), VFC Corporation (VF), and Lululemon Athletica Inc. (LULU) have sales models tilted

toward apparel. NIKEs the #1 brand in soccer footwear in nearly every major market, including Germany, the home of rival

brand Adidas AG (ADDYY).

Category revenues for footwear came in at $16.2 billion in fiscal year 2014, making up ~58.3% of total revenues. Footwear

sales grew at a compounded average growth rate (or CAGR) of 12% over the 20102014 period.

Category growth has been driven partly by higher unit sales, a shift in the sales mix to pricier models, and expansion in new

markets. Average selling prices of footwear have grown consistently in most major markets.

Key Revenue Earners Drive Pricing Power For NIKEBy Phalguni Soni- Disclosure Dec 2, 2014 4:00 pm EST
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Leading models include the LeBron range, the Pegasus 31, the LunarGlide 6 and the Free Flyknit, the NIKE Free Trainer 4

and Air Max footwear.

Apparel innovations provide pricing power for NIKE

Apparel is the second-largest category, accounting for 29.2% of revenues, or $8.1 billion in fiscal year 2014. Apparel sales

grew at a CAGR of 12.6% over the 20102014 period. Selling price increases have featured prominently, especially in the

larger reporting markets of North America, Western Europe, and Emerging Markets, excluding China. The companys also

tried to tilt the sales mix toward premium products, benefiting the top line.

NIKEs #1 in running apparel. The company has developed new premium running markets with products such as the Dri-FIT

Knit and Dri-FIT Touch performance tops. Other major products include the Air Max Lunar1, the NIKE Tech Windrunner

acket, and the Sportswear Tech Pack apparel range. Innovations like the Aeroloft vest give the company pricing power ove

competitors.

In 1Q15, apparel revenues grew in almost all major categories. The Sportswear, Soccer, Womens Training, and Running

categories experienced especially strong growth.

Equipment

Athletic equipment sales are the smallest product category, accounting for 6% of revenues, or $1.7 billion in fiscal year 2014

The category grew at a CAGR of 12.7% over the fiscal year period 20102014.

NIKE also has a targeted plan for each world market. The next part covers geographies and the products that will drive

growth.


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Revenue analysis for NIKE by geographical segment

NIKE, Inc.s (NKE) operations consist of the design, development, marketing, and selling of athletic footwear, apparel, and

equipment. Sales are seasonal and dependent on geography. Historically, Q1 and Q4 have been relatively stronger in terms

of sales. NIKE categorizes revenues by geography, except for its separate unit, Converse. NIKE has seven reporting

segments:

North America

Western Europe

Emerging Markets

Greater China

Central and Eastern Europe

Japan

Converse

NIKEs global markets: North American operations are far from tapped out

North America is the largest segment, accounting for ~44% of total revenues in 1Q15, up from ~37.3% in 2Q12. In

comparison, NIKEs major competitor in the US market, Under Armour Inc. (UA), derives over 90% of its revenues from Nor

America. Other NIKE competitors, VFC Corporation (VF) and Lululemon Athletica Inc. (LULU), also have a much higher

dependence on North American sales. In the last reported quarter, US sales as a percentage of total revenues were 59%

for VFC and 67% for Lululemon.

NKE, UA, and VFC are part of the Vanguard Total Stock Market ETF (VTI), the SPDR Consumer Discretionary Select Secto

NIKEs Global Markets: Top Revenue EarnersBy Phalguni Soni- Disclosure Dec 2, 2014 4:00 pm EST
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Greater China: High-return, high-performance markets for NIKE

Greater China made up ~8.5% of NIKE Inc.s revenues in 1Q15. The segments revenues grew at a CAGR (compounded

average growth rate) of 10.6% over the fiscal year period between 2010 and 2014, to ~$2.6 billion in fiscal year 2014. At an

operating profit margin of 31.4% in 2014, Greater China has the highest return on sales among NIKEs segments.

Although margins are high, theyve taken a dip recently. NIKE, Inc. (NKE) is now re-positioning itself in the Chinese market.

Its trying to create a more differentiated product portfolio.

Overhead has increased with the companys strategic investments in direct-to-consumer and new headquarters in Shangha

Higher discounts and closeout sales have also been factors. The companys objective is to increase retail profitability and

build a more segmented market. Key growth categories include Running, Basketball, and Womens Training.

Macro tailwinds in China

The Chinese segment should benefit from the Chinese governments efforts to increase consumer spending. Consumer

spending makes up just ~34% of Chinese GDP (gross domestic product). This is low when you compare it to Indias ratio of

62% or South Koreas 52% ratio. Faced with a slowing economy, the Chinese government is looking to raise the level of

consumption.

Consumer spending is likely to be a crucial growth driver in China going forward. This would benefit consumer discretionary

(XLY) companies like NIKE, especially considering the boom in sports and sports marketing in China. Some of NIKEs majo

initiatives in China include the endorsement of athlete Li Na and the opening of its second womens-only store in Shanghai,

Future High-Performance Markets For NIKEBy Phalguni Soni- Disclosure Dec 2, 2014 4:01 pm EST
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on November 29.

The iShares MSCI Emerging Markets ETF (EEM), the Vanguard Emerging Markets ETF (VWO), and the iShares China

Large-Cap ETF (FXI) provide exposure to Chinese equities.

Converse: An iconic brand presenting unique opportunities

NIKE acquired Converse in 2003. The Converse brand made up ~7.2% of NIKEs revenues in 1Q15, down from ~8.8% in

2Q12. The company expects to achieve $3 billion in revenues for the segment through fiscal year 2017. Its in the process o

converting licensees to a direct distribution model. This should provide opportunities for growing revenues. Licensees make

up about 50% of the global market. NIKE also plans to leverage Converse brands such as CONS or Jack Purcell, and

increase new apparel offerings to fuel growth.

These initiatives appear to be paying off for Converse. The segments operating income margin spiked sharply to 32.3% in

1Q15, overtaking Chinas 32.1% margin.

Read about the markets that could provide cause for concern, next.
http://marketrealist.com/quote-page/fxi/http://marketrealist.com/quote-page/vwo/http://marketrealist.com/quote-page/eem/


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Segments that could prove to be a near-term headache for NIKE

The Emerging Markets segment, which excludes China, is the third-largest for NIKE, Inc. ( NKE) in terms of sales. Emerging

Markets made up ~11.7% of total revenues in 1Q15, down from ~17.1% in 2Q12. The segments revenues grew at a CAGR

(compounded average growth rate) of 17.9% over the fiscal year period between 2010 and 2014, to ~$3.9 billion in 2014.

NIKEs forecast for Emerging Markets

NIKE expects revenues to grow to $6.5 billion by fiscal year 2017. Latin America, particularly Brazil, is expected to be a key

growth driver. The company expects Brazil to become its third-largest market globally in time for the Olympic Games in Rio

slated for 2016. NIKE is looking at the Running, Soccer, and Womens Training categories to drive growth.

That said, the larger Latin American economies of Argentina and Brazil have undergone significant currency depreciation inrecent years. Slowing or negative economic growth is another challenge. Mexico, another major economy, faced distribution

disruptions in 1Q15 that affected the profitability of the entire segment.

Central and Eastern Europe, Japan: Currency and macroeconomic headwinds may affect targets

Central and Eastern Europe and Japan are two smaller segments, accounting for 4.9% and 2% of total revenues,

respectively. While the NIKE brand is well received by the youth culture in both geographies, Central and Eastern Europe

revenues have experienced modest growth, while Japans revenues have declined during the period between fiscal years

2010 and 2014.

NIKEs Forecast For Emerging Markets: Current And FutureConcernsBy Phalguni Soni- Disclosure Dec 2, 2014 4:02 pm EST
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The company expects the Japanese market to grow in the mid-single digits through fiscal year 2017. However, currency

headwinds could see NIKE fall short of its target. The Japanese yen recently hit seven-year lows compared to the dollar, an

the trend is likely to continue.

The depreciation of the Russian ruble may also affect the mid-teen percentage growth target projected for Central and

Eastern Europe through fiscal year 2017.

Both the Japanese and Russian economies face economic growth challenges, although for different reasons. This could als

adversely affect revenues from these segments.

Some NIKE rivals more immune to global challenges than others

These challenges are less likely to affect competitors Under Armour Inc. ( UA) and Lululemon Athletica Inc. (LULU), as they

have lower exposure to these markets. Adidas AG (ADDYY) and VFC Corporation (VF) have more exposure overseas and

are also likely to be affected by currency and macro headwinds.
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Comparing NIKEs cost structure

Keeping a tight grip on costs is critical to any companys profitability and for shareholder returns. Some of NIKE, Inc.s ( NKE

margins are lower than those of its competitors. The companys gross profit margin, in particular, has trailed that of its

rivals Under Armour Inc. (UA), VF Corporation (VFC), Lululemon Athletica Inc. (LULU), and Adidas AG (ADDYY).

NIKE targets increase in gross profit margins

NIKE plans to expand its gross profit margin by an average of 0.3% to 0.5% per year through fiscal year 2017. Its looking a

few ways to do this:

Shifting to higher-priced premium products

Increasing the mix of retail (XRT) sales in overall revenues

Controlling costs through the use of innovative technologies

As discussed earlier, NIKE enjoys significant pricing power in the marketplace due to its ability to innovate and provide a

differentiated product. The firm plans to continue along these lines to expand its top line.

NIKEs shift to direct-to-consumer pays off

NIKEs also been investing significantly in expanding its retail foot-print through its direct-to-consumer strategy that we

covered in Parts 6 and 7. This includes both bricks-and-mortar retail and digital commerce. Currently, revenues to

wholesalers make up about ~78% of the sales mix. Retail sales generally have higher margins. An increase in the ratio of

retail sales would positively impact NIKEs gross margin.

Understanding NIKEs Cost Structure AdvantageBy Phalguni Soni- Disclosure Dec 2, 2014 4:02 pm EST
http://marketrealist.com/quote-page/xrt/http://marketrealist.com/author/phalguni-soni/#disclosurehttp://marketrealist.com/quote-page/lulu/http://marketrealist.com/author/phalguni-soni/http://marketrealist.com/analysis/stock-analysis/consumer/clothing/charts/?featured_post=143139&featured_chart=143142http://marketrealist.com/quote-page/ua/http://marketrealist.com/quote-page/addyy/http://marketrealist.com/quote-page/vfc/http://marketrealist.com/quote-page/nke/


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Selling, general, and administrative (SG&A) expenses

Despite the improvement in NIKE, Inc.s gross profit margins, SG&A costs have been on the rise over the past year.

Operating expenses made up 31.5% of revenues in 1Q15. Investments in retail, both online and bricks-and-mortar, have

impacted costs. Theyre also likely to increase going forward. Digital infrastructure, increased overheads, and event-driven

promotional expenditures are also likely to increase SG&A.

Tax rates

The effective tax rates for NIKE, Inc. (NKE) and VFC Corporation (VF) are significantly lower than for others. Both firms hav

benefited from higher overseas sales. Tax rates overseas are generally lower. The company is projecting an effective tax ra

of 24.5% in fiscal year 2015.

Regulatory requirements could hit NIKEs manufacturersNIKEs manufacturing operations are concentrated in lower-cost countries such as China, Vietnam, and Indonesia. Although

its manufacturing is contracted out, an increase in costs, especially on the labor front, would adversely affect profitability

targets.

Regulatory requirements to increase safety standards in factories may also result in cost increases for NIKEs manufacturer

The apparel industry has faced increasing backlash from human rights groups in the wake of the Bangladesh factory collaps

last year, which resulted in the deaths of 700 garment workers. Its thought to be the worst apparel factory accident in histor

Companies such as The Gap Inc. (GPS), Wal-Mart Stores, Inc. (WMT), and H&M have come together to set up a fund for th

NIKEs Manufacturers: Future Cost-Side HeadwindsBy Phalguni Soni- Disclosure Dec 2, 2014 4:02 pm EST
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victims and their survivors. Higher safety standards at factories are likely to see costs rise for NIKE and its competitors, Und

Armour Inc. (UA), VFC Corporation (VF), and Lululemon Athletica Inc. (LULU), and Adidas AG (ADDYY).
http://marketrealist.com/quote-page/addyy/http://marketrealist.com/quote-page/ua/http://marketrealist.com/quote-page/lulu/


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When a mature company capitalizes on growth opportunities

NIKE, Inc.s capital expenditures (or capex) have been on the rise for the past five quarters. In fiscal year 2014, capex

increased by over 47% to $880 million, year-over-year. NIKEs management is hoping to capitalize on growth opportunities,

which arent limited to developing emerging markets. Despite being categorized as a premium brand, the companys been

able to grow its revenues, even in the middle of the Great Recession.

The iShares Russell 2000 Growth (IWO), iShares S&P 500 Growth (IVW), iShares Russell 1000 Growth (IWF), and the

iShares Core S&P 500 ETF (IVV) provide exposure to NKE.

Future plans cost money

Growth opportunities abound and are driving NIKEs future spending plans higher:

Higher retail revenue potential Its push to drive higher retail revenues through bricks-and-mortar stores has resulted in higher

expenditures. The hi-tech premium image that the company puts across also means a higher investment on store rollouts.

The digital experience and e-commerce The company spends considerably on enhancing the digital experience for customers and

increasing e-commerce sales.

Research on innovative manufacturing technologies This would ultimately result in lowering the cost of production, but requires on-goin

investment.

As a percentage of sales, capex has risen from 2.4% in fiscal year 2013 to 3.2% in 2014. NIKE, Inc. (NKE) expects capex to

range from 3% to 4% of sales over the next few years. You can read about the impact of higher capex on the return on

invested capital in the next part of this series.

NIKEs Future Spending PlansBy Phalguni Soni- Disclosure Dec 2, 2014 4:02 pm EST
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Foot wars: Analyzing NIKEs competition

Under Armour needs decades to take out Nike, according to Under Armour Inc. (UA) CEO, Kevin Plank. Plank made the

comments during a recent interview with Bloomberg Television. Defeatist? Not really, just an acknowledgement of the

degrees of separation that lie between NIKE and the new kid on the block, Under Armour. NIKE, Inc.s been around for 50

odd years, while Under Armour started out in 1996.

Whats an economic moat?

The economic moat is an allegorical body of water that surrounds a profitable company, protecting its market share and futu

cash flows, much like an actual moat surrounding a castle. A company with a sustainable business advantage is said to hav

a wide economic moat. That makes it difficult for rivals to erode the firms competitive advantage or impact future revenues

and profits.

A company with a sustainable competitive advantage usually provides consistent above-average returns on the capital

invested in the business. As is apparent from the two charts, NIKEs returns have been consistent over the years, save for t

recession-marred fiscal year 2009. Despite the dip in profitability, revenues actually increased that year. NIKE, Inc.s ( NKE)

returns are also above those of competitor averages, including United Armour, VFC Corporation (VF), Lululemon Athletica

Inc. (LULU), and Adidas AG (ADDYY). United Armour, VFC, and NIKE are part of the S&P 500 Index (SPY).

Analyzing NIKEs economic moat and competitive position

The footwear and sports apparel industry has many players and few barriers to entry. Yet, NIKE is head and shoulders abov

the competition, both in terms of operating and financial performance. Its larger size means that its growth affects the marke

NIKEs Economic Moat: How Strong is it?By Phalguni Soni- Disclosure Dec 2, 2014 4:02 pm EST
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to an event greater extent. NIKE is the acknowledged market leader in footwear, running, soccer, and basketball.

In recent financial releases, management has discussed widening the degree of separation that lies between NIKE and the

other players in the market.

NIKEs ability to successfully innovate is critical for keeping its pricing power and the moat intact. The companys competitive

advantage has been built over the years due to its innovation and pioneering manufacturing practices.

The next part of this series will discuss the companys focus on improving returns on invested capital and free cash flow.


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Returns on invested capital (or ROIC) and the firms cost of funding

NIKE, Inc. (NKE) has successfully built a cult brand whose new products sell out within minutes of hitting the stores. The firm

has also demonstrated its pricing power. The must-have aura about its products have helped the company earn consistent

above-average returns, over and above its capital costs.

NIKEs above-average returns

NIKEs favored yardstick for measuring returns is the return on invested capital (or ROIC). The ROIC measures how much

cash flow is generated by a firms investments. Its calculated by taking net operating profits less adjusted taxes, and dividin

that by invested capital. Capital investments include those financed by both debt and equity.

The difference between the ROIC and the firms cost of funds, 1determines the excess economic value generated by the fir

over and above its cost of funds. A greater difference implies higher value and vice versa. As you can see in the chart, NIKE

ROIC was higher and its weighted average cost of capital (or WACC) was lower than the average among its competitors. Th

suggests that NIKE has generated higher economic value.

NIKEs competitors include United Armour Inc. (UA), VFC Corporation (VF), Lululemon Athletica Inc. (LULU), and Adidas A

(ADDYY). United Armour, VFC, and NIKE are part of the Vanguard Total Stock Market ETF (VTI), the SPDR Consumer

Discretionary Select Sector ETF (XLY), and the SPDR S&P 500 ETF (SPY)

Strategy going forward

Why The NIKE Brand Consistently Delivers Above-AverageReturnsBy Phalguni Soni- Disclosure Dec 2, 2014 4:03 pm EST
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NIKE is determined to generate higher positive cash flow and maintain ROIC in the mid-twenties range going forward. The

companys strategy hinges on a couple of things:

Better working capital and inventory management

Capital expenditure targeted at higher return investmentsfor example, retail store rollout, digital and e-commerce, and innovation

So far, NIKE is on track to meet its goals. ROIC came in at 26.2% in 1Q15, an increase of 0.7% over last year. As you can

see in the graph Part 17, the difference between the ROIC and NIKEs cost of capital appears to be widening, which

suggests economic value is increasing. The next part of this series will explain why.

1. weighted average cost of capital or WACC


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this series. This could see the firm increase the use of debt in its capital structure to finance capital projects. That would

enhance returns to shareholders.

The next part of this series will cover historical and future returns to NIKE shareholders.


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Dividends and growth: Analyzing NIKEs shareholder returns

NIKE, Inc. (NKE) is a well-established player in the footwear, sports apparel, and equipment space. Unlike new kids on the

block, United Armour Inc. (US) and Lululemon Athletica Inc. (LULU), its been around since the 1960s. The firms also raised

its dividend 13 years in a row. This is kind of unusual, considering that it likes to categorize itself as a growth company. And

growth companies generally dont like to pay out too many dividends, preferring instead to hold back the cash flow from

earnings to finance future growth opportunities.

The company is helped by the fact that its manufacturing is conducted mostly by third-party contractors, reducing the need f

repeated capex injections. This factor also helps the company grow organically, and not necessarily through acquisitions.

NIKE is a part of both growth- and dividend-oriented exchange-traded funds such as the iShares S&P 500 Growth (IVW), th

Vanguard Dividend Appreciation ETF (VIG), the iShares Russell 2000 Growth (IWO), the iShares International SelectDividend (IDV), and the iShares Select Dividend (DVY). Its also part of ETFs tracking broad-based market indices such

as SPY and DIA.

Do NIKEs Shareholders Enjoy A Best-Of-Both-Worlds Advantage?By Phalguni Soni- Disclosure Dec 2, 2014 4:03 pm EST
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Rivals UA and LULU havent paid a dividend as yet. The upside for shareholders in the short and medium term must come

from share price appreciation. Looking at the five-year total average shareholder returns, both firms havent done too badly.

Both have, in fact, performed better than NIKE. But the lack of dividends can contribute to returns volatility. For

example, LULUs total returns over the last year have been negative.

Benefits of increasing dividends to shareholders

When dividends are consistently increasing, it signals management confidence in the companys ability to consistently

generate increasing cash flows. A dividend can also provide some upside to your portfolio, even when a stock is getting

hammered in the short term.

Share buybacks spike returns for NIKEs shareholders

Management aims to return more cash to NIKEs shareholders in the form of share buybacks. They authorized an $8 billion

four-year share buyback program in 2012. Share repurchases totaled $2.6 billion in fiscal year 2014. These, along with the

improvement in margins and lower tax rates we discussed in Part 15, have positively impacted earnings per share (or EPS)

EPS came in at $2.97 in fiscal year 2014. NIKE expects a comparative increase in the region of 20% in its 2015 EPS. Read

about NIKEs relative valuation in the next part of this series.
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NIKEs fundamental value: Does the shoe fit?

NIKE, Inc.s (NKE) management aim to deliver returns to shareholders in the top quartile of the S&P 500 Index (SPY). In thi

part of the series, we compare NIKEs valuation to those of its peers using a cross-sectional analysis.

The first graph below pits each companys forward EV-to-EBITDA1multiple with the two-year expected growth rate in

EBITDA. A higher EV/EBITDA multiple is justifiable, provided the company is expected to grow commensurately in the futur

and vice versa.

In the graph below, United Armour Inc. (UA), with a growth rate of over 25% per year, is valued at a multiple of just under 36

NIKE, VFC Corporation (VF), and Adidas AG (ADDYY) are all falling below the trend line, suggesting an upside in stock

prices may be in the cards. Annual expected growth rates in EBITDA for the three firms range from ~10.6% for ADDYY to

13.8% for NKE.

Determining NIKEs Fundamental ValueBy Phalguni Soni- Disclosure Dec 2, 2014 4:04 pm EST
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NIKE versus the competition

In this series, were focusing specifically on NIKEs fundamental value and historical performance. The companys

performance, while lagging behind most others in terms of the total shareholder returns metric, has been consistent over a

longer period.

For example, United Armour and Lululemon Athletica Inc. (LULU) are new kids on the block, relatively speaking. The

upside for shareholders of these companies has come from share price appreciation. Neither company has the geographica

diversification enjoyed by the other three firms.

NIKE is also significantly larger than the peer group. Its market cap is ~2.6x that of VFC, its nearest rival. So the growth rate

are calculated over a relatively larger base.

The annual average increase in NIKEs EBITDA over the past five years has been 13.9%, slightly ahead of the 13.8%

estimate used in the model. The tilt toward retail and digital commerce would positively impact future margins and EBITDA.

The upside for the consumer discretionary sector (XLY) is also likely to come from an improving US economy and labor

market.

Based on these assumptions, NIKE appears to be slightly undervalued.

Could there be some bumps in the road ahead for NIKE? Read about the key risks to NIKEs returns in the concluding part

this series.

1. enterprise value-to-earnings before interest, taxes, depreciation, and amortization
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Threats to NIKEs business model

While the outlook appears rosy for NIKE, Inc. (NKE), there are some thorns, too, that could challenge the companys ability

achieve its financial and operational targets.

Exposure to overseas markets and currencies

Compared to its rivals, United Armour Inc. (UA), VFC Corporation (VF), Lululemon Athletica Inc. (LULU), and Adidas AG

(ADDYY), NIKE derives a larger portion of its revenues from overseas markets. This leaves the firm vulnerable to both

economic cycles in other geographies and adverse currency movements. Either of these variables could reduce NIKEs

profits, as noted earlier in this series.

In the current context, this overseas exposure risk is particularly applicable. Economic growth has been subdued or even

negative in major economies including China, Japan, Brazil, Argentina, Russia, and Western Europe. Currencies in these

countries have also depreciated significantly this year against the US dollar. NIKE could face heat in most of these econom

apart from China, as discussed in Part 13.

In contrast, rivals UA and LULU, which derive over 75% of revenues from the US market, could benefit from the geographic

tilt. The US economy is growing and so is consumer spending. Third-quarter gross domestic product grew by a larger-than-

expected 3.9%. Consumer spending is also on the rise, increasing 3.6% year-over-year in October. US sales are particularl

relevant now for consumer-oriented firms in the run-up to the holiday season that started just before Thanksgiving and

continues until the New Year.

Variables that could threaten NIKEs Business ModelBy Phalguni Soni- Disclosure Dec 2, 2014 4:04 pm EST
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You can gain exposure to UA and NIKE through the the SPDR S&P 500 ETF ( SPY) and the SPDR Consumer Discretionary

Select Sector ETF (XLY).

Competitiveness, similar strategies adopted by rivals

Although NIKE leads the market by a wide margin, rivals could possibly emulate its premiumstrategy in an attempt to eat in

its market share. Still, it would take years to build the brand that NIKEs got.

Adidas could be its closest competitor in a global context, but its got its work cut out for it in the US market. That said,

the newly revamped Reebok brand and retail push may pose a threat in the casual sports apparel segment.

To stay ahead, NIKE must continue to launch innovative products and maintain the width of its economic moat, as discusse

in Part 17 of this series.

Consumer price sensitivity

Higher-priced products also leave NIKE vulnerable to consumer preferences. Although the company proved to be relatively

resilient in the most recent recession, an economic downturn could reduce demand and unit sales.

Supply chain risks

As mentioned earlier in the series, all of NIKEs manufacturing is outsourced to third-party contractors in countries

including China, Indonesia, and Vietnam. Government legislation regulating factories or an increase in input costs, especial

labor costs, could present challenges to NIKEs financial goals.

To read more sector updates, visit Market Realists Consumer and Retailpage.
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