Global Direct-To-Consumer Growth May Reduce Nike’s Premium

Key Takeaways

• While Direct-To-Consumer sales may improve Nike’s margins, it will make it harder for the company to retain their market share.
• The market is more accessible and Nike has to find ways to stay ahead of marketplaces, retailers, fast fashion brands, outlets, etc.
• Brand name and innovation may not be enough to justify a 30x PE premium.
• The office casualization trend is a viable growth vertical, but may not be as suitable for Nike, compared to casual footwear brands.

Catalysts

The Rise In Direct-To-Consumer Helps Competitors As Much As Nike

Nike’s Direct-To-Consumer (DTC) revenues grew 6% from $5.1B in Q1’23 to $5.4B Q1’24, and represented approximately 43% of total Nike brand revenues for Q1’24. Digital stores are the first step in the sales cycle as 90% of customers start their journey there. This may seem like a lot but it makes sense when you consider most purchase decisions usually begin with an internet search, which usually yields several online shopping listings for the item. Nike has posted a large DTC growth over the years with a 5-year CAGR of 12.6%.

Statista: Nike’s DTC annual revenue

This is important, as some analysts rightfully point out that digital sales growth increases profitability because Nike won’t have to maintain numerous physical stores and will control the advertising on their digital assets.

Conversely, Nike is not alone in exploiting the rise of DTC. Small business, outlets, retailers, and fast fashion chains have also been scaling up their direct to consumer supply chains. Marketplaces like Zalando and fast fashion brands like Inditex, H&M, now offer better access to their own and smaller brands. Nike has to move fast on DTC, but there is little it can do, as DTC is an easy growth avenue that will benefit competitors and keep fracturing market share as more businesses look to tap into the opportunity. 

Ultimately, A more fractured market share could see Nike losing out to cheaper competitors as most decisions made in DTC purchases are based largely on price as consumers are forgoing the opportunity to ‘try before you buy’.

Product Innovation is Overstated in Footwear

Nike frequently points out innovation in their investor relations. However, I find it hard to imagine how this innovation can be protected against competitors that decide to make similar products.  

Investing in footwear innovation may have limited growth potential, and may be more of a marketing move directed at investors. In my view, Nike’s biggest asset is its brand name, and any innovation produced will be adopted by competitors despite legal protections. Meaning, if investors are relying upon innovation to drive future revenue growth, I believe they will be disappointed. 

Revenue and Margin Headwinds Will Be Short Term  

Management expects (p. 12, 13) mid single digit revenue growth by the end of the year, and only a slight growth in Q2 revenues, in an effort to further manage working capital by employing more holiday inventory markdowns. 

On the other hand, I’m expecting Nike to experience positive tailwinds such as a reversal of high input costs (albeit they’re still high - page 13), while freight costs have already normalized. This will mitigate the negative effects of an economic slowdown. 

Overseas freight prices had been an issue for Nike in the past three years as most of their products are made in Asia and had to be transferred by container ships that were expensive for that period. Inventory increased in the post 2021 since Nike expected consumers to keep spending, and the market didn’t have a sense of how market tightening would unfold. This led to an inventory build-up and the company has been slowly reducing it ever since.

Statista: Global container freight rate index

Analysts expect revenues for Q2’24 around $13B. The quarterly forecast may suffer pressure because of seasonal discounts. Despite this, Nike seems to have stabilized costs and inventory enough so that these headwinds are relatively short-term. 

The Highly Competitive Landscape Makes Nike’s Leadership Position Unstable

Nike has a number of high growing competitors that are gaining market share. Comparing peers by size, Adidas is Nike's biggest competitor, with annual revenue of over €22B, next is Puma with € 8.9B. Under Armour is a newer competitor known for its performance-oriented product, and has quickly grown to become one of the leading brands in sportswear.

SimplyWallSt: Nike’s Forward PE comparison to top peers

The combined revenue of all the mentioned peers is around $106B, with Nike holding some 50% of the market share:

• NKE $51.5B
• ADI €22.2  = $23.5B (owns Reebok)
• PUM €8.9 = $9.41B
• SKX $7.8B
• UA $5.9B
• DECK $3.7B
• ONON 1.6B CHF = $1.77B
• BIRK $1.5B
• LULU has likely less than $1.14B in footwear revenue. Coming from 13% of its $8.8B revenue, which is categorized as part of its “Other” segment, and is more of a limiting factor on Nike’s growth, rather than a direct competitor.

Lulu and Brickenstock have good performance and compete for the office casualization trend - characterized by the de-formalization of office wear and a move to a more casual office wardrobe inspired by the work from home trend which persists for some 13% to 28% of U.S. employees in 2023.

Being at the top of the hierarchy both on market share and margins, can be unstable, as companies have difficulty retaining a high level of market share in a highly competitive industry. Additionally, the high margins Nike earns implies it has a strong brand and is used by people as a way to signal status instead of having unique qualities. 

There is nothing wrong with this approach, however I think that economic pressures will force consumers to switch from buying status items to items with better price to performance ratio. And if not that, I assume they’ll simply slow down their discretionary purchases, and not buy as many Nike shoes per year as they may have before in more favorable economic conditions.

Assumptions

• Business: Competition will keep fracturing the footwear market, as peers continue scaling their global supply chains, making it harder for Nike to keep their 50% market share based primarily on brand name. I estimate a revenue growth rate of 6.1%, resulting in $54.6B in the next 12 months, and $69.2B in 2028.
• Margins: I expect Nike to return to historical levels on its net profit margin and reach 11.5% by 2028.
• Buybacks: The company has authorized buybacks $1.13B for the first quarter of fiscal 2024 and a remaining $12.1B authorized in its buyback program. Nike has reduced its share count by an average of 1.4% in the last 2 years, and I expect this trend to continue. This will bring Nike’s outstanding share count from 1.52B to 1.42B in 2028.
• Forecast: With revenues of $69.2B and a net profit margin of 11.5%, I estimate that Nike makes $8B in net income in 5 years.
• Multiple: I estimate that Nike re-rates to a lower PE multiple of 21x by 2028, as the company matures and experiences a fracturing in market share.

Risks

• Equipment sales (p. 23): had the best performance and may turn into a high-growth vertical allowing the company to use its brand name and distribution channels to expand into new product markets.
• FX impact: Nike has some 58% of its revenue coming from outside the US. If the dollar strengthens against foreign currencies, Nike's products will become more expensive for consumers outside the US, leading to a decrease in demand. The risk here is that the FX impact could be significant enough to result in far less earnings than what my assumptions have detailed.
• Inflation: As consumers experience reduced purchasing power, they may stave off discretionary purchases and choose alternatives such as Sketchers or off-brand items.
• Reputational risk: Nike is relatively unscarred from recent polarization but could divide part of its customer base if it actively engages in controversial marketing.