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Nike Disappoints on Higher Costs

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Nike Inc. (NKE), a global leader in sports equipment and apparel, reported fourth-quarter 2012 and fiscal year 2012 results. The company’s earnings for the quarter slumped 6% year over year to $1.17 per share. Quarterly earnings also missed the Zacks Consensus Estimate of $1.37 per share by a great margin. Diminished gross margin, higher SG&A expenses, increased tax rate and expenses associated with restructuring of NIKE Brand Western Europe’s operations played spoilsports during the quarter.

On the other hand, earnings per share for fiscal 2012 jumped 8% compared with last year to $4.73, but fell short of the Zacks Consensus Estimate of $4.94 per share. Results benefited compared to last year on account of robust sales growth, lower SG&A expense and reduced share count, which largely offset the contracting gross margins and increased taxes.

In the fourth quarter, Nike's total revenue grew 12.2% to $6,470 million from $5,766 million in the prior-year quarter, primarily driven by growth in all key categories, products and geographies of NIKE Brand. Revenue for the quarter, however, lagged behind the Zacks Consensus Estimate of $6,488 million. Fiscal year revenue rose 15.7% to $24,128 million while it missed the Zacks Consensus Estimate of $24,162 million.

Fourth Quarter in Depth

Nike's quarterly gross profit surged 8.3% from the year-ago quarter to $2,767 million, while gross margin contracted 150 basis points to 42.8%. The margin contraction mainly resulted from higher product costs, increased digital business investments and a sudden customs assessment raised in the emerging markets relating to the imports that have taken place in the last four years. These negatives nullified the effect of the positive pricing actions, lower air freight, as well as the benefits of the ongoing cost reduction initiatives.

Selling and administrative expenses for the quarter grew 12.1% to $1,986 million from $1,772 million in the year-ago quarter. Earnings before taxes (:EBT) declined 3.9% to $743 million from $773 million in the year-ago period. EBT margin contracted 190 basis points from the prior-year quarter to 11.5%.

Global inventories rose 23.4% year over year to $3,350 million. Most of the growth in inventories of NIKE Brands are characterized by higher product input costs and an altered product mix, while some of the upside were driven by a 10% rise in NIKE Brand unit inventories. Nike ended the year with cash and cash equivalents of $2,317 million compared with cash balance of $1,955 million in the year-ago period.

During the quarter, the company repurchased 2.3 million shares for about $245 million as part of its 4-year, $5.0 billion share repurchase program approved in September 2008. As of year-end 2012, the company’s total share repurchases under the program totaled 50.3 million for an aggregate value of $4.1 billion.

Our Take

Nike is the industry leader in the U.S. footwear and athletic apparel industry. In an attempt to expand its global reach and market share, Nike is aggressively expanding its operations in the emerging markets while focusing on direct-to-consumer business and other brands, which augur well for future operating performance. In fiscal year 2012, Nike showed significant strength by innovating its products and services that helped to boost its top lines.

Moreover, the company’s near-to-debt free balance sheet offers financial flexibility to drive future growth.

However, Nike faces intense competition in both domestic and international markets from local as well as established players, such as Adidas AG (including Reebok), PVH Corporation (PVH) and Brown Shoe Company Inc. (BWS). These companies are primarily in athletic wear and intend to grab market share in active wear or lifestyle consumer products.

Currently, Nike maintains a Zacks #3 Rank, which translates into a short-term Hold rating. We retain a long-term 'Neutral' recommendation on the stock.

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