Nike's Opportunity in Emerging Markets Outweighs Higher Costs
Nike ( NKE ) is the largest global manufacturer of athletic footwear, apparel and equipment by sales volume, and competes with Sketchers ( SKX ), Adidas AG ( ADS ), Steve Madden ( SHOO ) and K-Swiss ( KSWS ) in the global footwear market. The company recently announced its Q3 2011 results. Although Nike's revenues increased 7% to $5.1 billion, the gross margin declined 110 basis points to 45.8% compared to same period last year. The decline in margin was basically because of higher product and freight costs. We have highlighted these factors in our earlier note titled: Nike's Air Freighting Raises Questions on Inventory Management .
Nike has a strong brand identity that it can leverage to raise prices, thereby offsetting higher costs. Nike is also focusing on expansion plans, particularly in emerging markets, which has shown strong demand for Nike branded footwear. We expect higher volumes and effective supply chain model by Nike will plug any further margin declines.
While we anticipate Nike's footwear gross margin will be relatively stable at around 46.4%, Trefis members predict the margin approach 52%, implying an upside of 5% to our price estimate for Nike's stock. We currently have a Trefis price estimate of $77.52 for NIKE's stock , ahead of the current market price of $75.57.
Nike Could Raise Prices to Offset Costs
While the impact of rising commodity and transportation costs are likely to weigh on all footwear and apparel manufacturers, Nike's status as market leader would allow the company to withstand these pressures more effectively. The company can manage its profit margins by raising prices on select items and by using a more flexible inventory and supply chain model to respond to cost pressures and new opportunities as they arise. According to an analyst for Credit Suisse, Nike sets apparel prices a few months in advance of distribution, so any near-term price declines could stem from misjudgment of input cost increases.
In addition, being an established brand, Nike can utilize its bargaining power with suppliers, reducing the impact of industry-wide input cost increases and sustaining profit margins. (See: Nike's Capacity to Raise Prices Can Neutralize Impact of Rising Input Costs )
Nike to Profit from Emerging Markets
While China is contributing to increased production costs for Nike, it also presents expansion opportunities. Nike's management has indicated that the company sees a significant market potential for branded sports products in China, Brazil and other developing countries.
At the end of FY Q3 2011, the company reported overall future orders (scheduled for delivery from March-July 2011) of $7.9 million (up 11% from last year) for Nike brand athletic footwear and apparel. The highest growth from the total amount of orders came from emerging markets (up 21% from last year). This is an indication that Nike is taking its business from emerging markets seriously. We expect higher volume sales from these regions to offset higher input costs.