On Thursday, Nike Inc. (NYSE:NKE) reported results for the fourth quarter of fiscal 2020.
Revenue for the quarter declined by nearly 40%, which reflects the impact of retail closures around the world throughout much of the quarter. Revenue declined in all regions in the quarter, with Greater China showing minimal year-over-year growth (up 1%) on a constant currency basis.
The difficult results reflect the impact of Covid-19, which hurt Nike’s results in the third and fourth quarter. That led to a split for the year, with first-half revenues climbing by 9%, offset by a 17% decline in the back half of the year. The net result was a 4% decline in revenues in fiscal 2020 to $37.4 billion – the largest annual revenue decline that Nike has reported in more than a quarter century (sales fell by 4% in fiscal 1994).
Despite the headwinds experienced in Greater China, most notably in the third quarter, constant currency revenue in the region increased double digits for the sixth consecutive year. As shown below, Nike’s Greater China business has more than doubled over the past five years, and now accounts for nearly 20% of the company’s total revenue.
While the brick-and-mortar business struggled in fiscal 2020 as a result of pandemic-related closures, the digital business picked up much of the slack. In the fourth quarter, digital revenue increased by 75% to $1.9 billion, equal to 30% of Nike’s revenue in the period. For the full year, digital revenue increased by nearly 50% to $5.5 billion, accounting for 15% of the company’s business.
As noted on the conference call, the company’s digital success accelerated throughout the fourth quarter, with digital business up triple digits in May. In addition, after quarter-end, even as stores have reopened, management noted that they’ve maintained this momentum throughout June.
As CEO John Donahoe noted on the conference call, Nike will continue to invest to ensure that they are fully capitalizing upon the digital opportunities in front of them:
“As I said earlier, NIKE is in a position to emerge from the COVID-19 pandemic even stronger due to our Consumer Direct Offense. The global pandemic has made it clear that consumer behavior is changing rapidly, providing the opportunity for us to accelerate the pace of our transformation. Over the past few years, we have shifted from a legacy wholesale distribution model to investment in a model that gives our consumers a more premium shopping experience. And this is a change that has catalyzed our digital growth as part of our true Consumer Direct Offense. And COVID-19 has shown that our strategy is sound… we plan to accelerate our focus and investment on the key areas to put an even sharper point on our highest growth opportunities… We aren’t settling for our current leadership position with consumers or in digital. We’re pursuing even further separation… Now is the time to act.”
Importantly, Nike’s digital transformation results in a more direct relationship with the customer. This enables them to appreciate the needs and desires of customers more fully in order to develop and deliver products and services that satisfy their demands. In addition, as Chief Financial Officer Matthew Friend noted on the conference call, digital provides financial benefits to Nike as well:
“A more digitally connected NIKE is a more valuable NIKE. The underlying value proposition of NIKE’s Consumer Direct Offense is that the consumer adoption of digital across all aspects of life now provides NIKE with an opportunity to create deeper, more direct consumer relationships at scale without disintermediation. As we’ve said before, the transformation to a more digital and direct business is financially accretive to NIKE.”
While outsized growth in the digital business is encouraging, the reality is that Nike still had to deal with a massive overhang from stores (both company-owned and those of its retail partners). The significant decline in revenue in the back half of 2020 led to a 31% year-over-year increase in inventories on hand at year-end 2020. This mirrors what we saw at Under Armour (NYSE:UA)(NYSE:UAA), with Nike management drawing similar conclusions about its future impact: this will likely lead to a more promotional competitive environment in the coming quarters. For Nike, that process has already started, with promotional activity resulting in a roughly 250 basis point headwind on gross margins in the fourth quarter.
Looking ahead, management expects things to remain difficult in the short term. In the first half of fiscal 2021, it expects revenue to decline along with gross margin compression as a result of outsized promotional activity. For the full year, they’ve essentially guided to a low single-digit increase in revenue – a lackluster result after a tough 2020 from the viewpoint of investors who have become accustomed to mid-to-high single-digit annualized revenue growth from Nike.
While Nike is clearly facing short-term challenges (along with its competitors), Mr. Market is still giving the company a long leash. Consider the last time Nike reported a decline in annual revenue was in fiscal 2010: around that time, the stock traded for roughly 15 to 20 times trailing earnings. Today, by my estimation, normalized trailing earnings are $2.5 to $3 per share. At a current stock price of $94 per share, the stock trades at more than 30 times trailing earnings.
As shown below, the current price-sales ratio is much higher than it has been over the past decade as well (this metric has its shortcomings, most notably as it relates to changes in the margin profile, but it provides a clean view of how investor percpetion has changed over time).
That’s a long way of saying that I’m a bit surprised Mr. Market is so willing to overlook the company’s (hopefully) short-term challenges. By management’s own admission, results over the next six months are likely to be uninspiring – and that likely does not assume another round of closures if fears about the impact of the pandemic ramp up again.
Personally, I need a cheaper valuation before I would add Nike to my portfolio. I would love to own this business for the long term if the price was right, but I don’t think we’re there today.
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This article first appeared on GuruFocus.