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Why Nike Has Investment Appeal

- By Robert Stephens, CFA

Nike Inc.'s (NKE) growth strategy is set to deliver improving profits, which could lead to further outperformance of the S&P 500.

The company is focusing on its digital offerings, which may improve the customer experience and lead to stronger loyalty. Its investments are being targeted on new products as well as its growth potential in China.


While proposed tariffs could hurt its financial prospects, Nike's improving efficiency may help to offset headwinds to some extent.

Having climbed 21% in the last year versus a 5% rise for the S&P 500, the stock could offer further capital growth potential.

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Digital investments

Investments in the company's digital offering could improve its competitive advantage. It recently rolled out the Nike App in its retail stores across Europe, North America and Japan, which resulted in double-digit membership growth. Member growth is expected to increase customer engagement as well as strengthen loyalty through creating a more personalized experience.

The company plans to focus on mobile engagement, delivering a number of new initiatives to forge stronger relationships with customers. For example, it is investing in a new editorial content engine that will provide increased engagement with members, while also rolling out new digital services that improve the customer experience.

In addition, a new advanced algorithm was launched in the company's app last quarter that rewards its most loyal members. This could further improve spending levels per customer as consumers who used the app at Nike's retail locations averaged 40% higher sales than those who did not in the most recent quarter.

Innovation

Nike is seeking to become increasingly innovative in terms of its products. It plans to deliver a faster cycle of new key products, including a wider variety of colors and materials that will appeal to more consumers.

The company's product pipeline includes a new cushioning system that is aimed at encouraging increased participation in the running segment. It also intends to launch more than 40 new styles of sports bras in order to expand its inclusive sizing.

Further product innovation in China presents the business with a potential growth catalyst. Last quarter, its currency-neutral revenue growth was 24%, making it the largest footwear and apparel market in the world. Those two segments, though, represent a smaller share of total retail spending in China than in more developed markets such as the U.S. As a result, the company could expand rapidly as it seeks to capitalize on the increasing popularity of running.

Risks

With around 18% of products currently manufactured in China, Nike could be negatively impacted by proposed tariff increases. Although the company may be able to absorb some of the additional costs, a 25% tax will have to be at least partially passed on to U.S. consumers in the form of higher prices. With U.S. retail sales having risen just 1.3% since August 2018, the retail landscape is already relatively weak. Tariffs may, therefore, put pressure on the company's performance.

In response, Nike is seeking to improve the efficiency of its supply chain. At the factory level, it is staging raw materials so they can be quickly deployed to fulfill requests for its most popular products. The company's Express Lane program, which focuses on direct-to-consumer sales, is expected to grow as a percentage of its overall business. In addition, the company is investing in responsive manufacturing and faster delivery capabilities for its key cities.

Outlook

In the next fiscal year, Nike's earnings per share are projected to grow 19%. This helps justify its price-earnings ratio of 32, and suggests it may offer good value when its long-term growth potential is factored in.

With Nike's planned investments in digital services and new products, as well as its growth potential in China, the rate of profit growth could remain high over the long term.

Although there are risks facing the business from an escalation in the U.S.-China trade war, its improving efficiency could offset the effects to some extent.

Having outperformed the S&P 500 over the last year, the stock could deliver further capital growth potential over the long term.

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This article first appeared on GuruFocus.