Key Points
Nike has stopped the decline in sales, but falling margins continue to pressure profitability.
Gross margin trends will determine whether earnings can reaccelerate.
Execution will decide whether Nike can regain its growth trajectory.
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After several difficult quarters, Nike (NYSE: NKE) has finally stabilized its revenue, indicating progress in stopping the decline.
But margins are still moving in the wrong direction. In its latest quarter, Nike reported a gross margin of about 40.2%, down 130 basis points year over year. Net income fell much more sharply.
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That gap tells the real story. While Nike has stopped the slide in sales, it has not yet rebuilt its earnings power.
Image source: Getty Images.
Early signs of stabilization
Once a giant in the sports industry, Nike shocked its investors when it reported a 10% decline in revenue for fiscal year 2025, ended May 31, 2025.
Fortunately, the company has quickly entered turnaround mode, and so far, the results have been reasonably promising.
In its fiscal year 2026 third-quarter (Q3) results, ended Feb. 28, revenue came in roughly flat. Wholesale revenue (Nike selling to retailers) grew 5%, helping offset weakness in Nike Direct revenue (down 4% year over year). Similarly, inventory levels improved, down by 1% year. These figures suggest that Nike has largely regained control of its business, preventing it from an endless downward spiral.
Still, it's not the time to celebrate, since Nike continued to struggle to improve a key part of its business model – margins. More in the next section.
Why is it crucial to stabilize margins?
One key metric for a retail brand like Nike is its gross margin. The idea is that a sustainable and improving margin indicates its pricing power and growing brand influence.
And here's where Nike continues to struggle: Gross margin has fallen from 41.5% in the third fiscal quarter of 2025 to 40.2% in fiscal Q3 of 2026. A declining gross margin is a significant challenge, as it reduces a business's operating leverage. That means Nike may have to cut expenses -- such as administration and marketing -- to maintain its long-term profitability.
While cutting costs may make sense to improve profitability, it may not be the best approach for a company trying to regain its brand power. Nike chose to keep spending to protect its brand -- and expenses grew by 1% in the latest quarter. The downside is that net profit took a massive hit, down 86% year over year.
In other words, unless Nike stabilizes its gross margin, the battle for profitability is still ongoing.
What does Nike need to get right to improve margins?
Fortunately, Nike does not need a dramatic shift. It needs to execute steadily across these fronts.
First, full-price sell-through must strengthen. When customers buy new products without discounts, it signals that Nike is slowly regaining its pricing power.
Second, gross margin must trend higher over multiple quarters. One strong quarter is not sufficient.
Third, the company must control its operating expenses to improve profitability.
Fourth, inventory must remain aligned with demand. In other words, no massive spike in inventory in any single quarter.
These are simple signals, but they determine whether Nike's earnings can grow again.
What does it mean for investors?
Nike has already done the easier part. It has stabilized revenue and reduced inventory risk. So far, the turnaround has progressed in the right direction.
Now it must do the harder part: Rebuild its brand appeal, which ultimately reflects in its margins.
If Nike moves margins from a declining mode back to growth, it can return to its historical trajectory of rising earnings per share (EPS) over the long run. Of course, this assumes that revenue also moves in a positive direction.
Improving profitability will be a huge win for investors, as it will drive a higher share price in two ways: higher EPS and potentially a higher valuation multiple.
In short, investors looking to win with Nike's stock will need to watch closely how well Nike performs on its margins.
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Lawrence Nga has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nike. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
