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Nike is focusing on its DTC business ‘at the expense of Foot Locker,’ analyst says

BTIG Managing Director Camilo Lyon joins Yahoo Finance Live to discuss company earnings for Nike as well as third quarter expectations amid supply chain disruptions.

Video Transcript

BRIAN SOZZI: Nike's earnings will hit after the close today. And the Street is a little nervous on how things panned out for the sneaker giant. The company is still dealing with supply chain snags from the pandemic, mixed demand in China, and new inflationary pressures. Camilo Lyon covers Nike at BTIG and joins us now. Camilo, always great to get some time with you. Look, Foot Locker, a couple of weeks ago, came out, reported. The stock was absolutely battered into the ground. Is that a potential tell on how Nike is going to report later on?

CAMILO LYON: No, and thanks for having me, Brian. It's good to always speak with you. No, I wouldn't get a-- I wouldn't take a direct read from Foot Locker to Nike. You really-- Foot Locker's results were effectively promulgated by Nike's actions. So that's to say that Nike has effectively made a much more definitive turn on focusing on its direct-to-consumer business at the expense of Foot Locker.

So the contacts that we have in the space and the conversations we've had with those industry contacts really suggests that the issue that Foot Locker is facing is one of less Nike product to the benefit of its competitors, as well as to Nike's DTC, as opposed to a demand issue for Nike. Now that's not to say that there aren't other issues that we're on the lookout for with respect to Nike here in the near term. But we don't take a readthrough from Foot Locker's results as a negative view on Nike.

JULIE HYMAN: Yeah, I know there's a lot to say about what's going on in China, but I have a bigger picture question first, Camilo, which-- and this is based on anecdotal information. I went to a bat mitzvah last weekend, and I would say 80% to 85% of those 12 and 13-year-old girls were wearing a little black dress and Air Force ones. And I've just been sort of amazed by the popularity and demand for Nike over a longer term as a trendy shoe. And I'm just curious how long that kind of cycle can last. Because it's lasted already for quite a while.

CAMILO LYON: Yeah, 100%. Again, the situation that we find ourselves in with Nike and really a lot of the stronger brands today is not a demand issue. It's really more a supply issue. Or that's what it's been for the last two years. Now we do have new pressures on the consumer that we're all trying to figure out the duration of, like inflationary pressures, rising rates, and the like, and rising prices pretty much across the board, which Nike is going to do in the back half of this year.

But by and large, this has not been a demand issue. And Nike has done an incredible job over the course of its history of creating demand for its products. Now that's also been propped up by a relative lack of supply in the market, too. So again, it's not really a demand issue, nor a style or on trend issue. It's really more the supply component that really keeps us up at night, at least as it pertains to the North American market.

BRIAN SOZZI: Camilo, what do you make about some of these competitors? We just talked to the folks over at OnHoldings. They seem to be having gained a lot of good shelf space at major retailers. They told us their pipeline for the spring selling season is strong. Should Nike worry about them and other upstarts like it?

CAMILO LYON: On is an interesting company. It's one we don't cover, but we track it because we do cover competitors of On, like HOKA, that's owned by Deckers. You know, these brands that have created some shelf space and some really hot attention for themselves in the running category doing well and bring forward a new view on the technology with respect to running. Again, we're talking two very different scale comparisons between Nike and an On or a HOKA. And so we're not really dismissing the competitive environment, but we're also not really concerned with it too much because Nike does have this brand halo above it that casts a much wider net than the other competitors around it.

Now the other thing, too, that's an interesting point to call back to is that the interesting stat when we talked about Nike running is, 95% of the consumers that buy Nike running shoes do not use them to run. They use them for more aesthetic, casual purposes, everyday purposes. So when we're talking about On or we're talking about HOKA, we're really talking about more technical running footwear. And again, so that creates another point of distinguishing separation between it and Nike.

JULIE HYMAN: Yeah, that's a really good point, Camilo. I want to come back to the supply chain for a minute because as you say, the scale is very different. But one other thing that stands out about On is that a lot of its supply chain goes through Vietnam. And I wonder, when you're looking at the supply chain issues for Nike now, what does it need to do to tweak its supply chain? Does it need to get more diversified, for example?

CAMILO LYON: Well, diversification has been happening for years now. And that's come at the behest of its manufacturing partners, a lot of whom are Chinese businesses that have diversified outside of China, largely due to labor pressures that have been pretty systemic and structural in nature for the past five or so years. COVID has exacerbated issues from a production perspective, but remember, you know, to use the On example, we're talking about Nike being a battleship and someone like On or HOKA being speedboats. So the time it takes to turn those businesses around is very different from a production perspective.

I do believe that Nike is exploring other countries to ramp up and have redundancies in. That's the info that we get and the intel that we get from our contacts in the manufacturing community. But again, those are longer term initiatives. The scale that Nike produces that we're talking hundreds of millions of pairs of shoes annually. So it doesn't happen overnight. Factories are tapped to build out lines. And to build out the expertise that it takes to create these shoes does take time. So there aren't really tweaks that can happen overnight. These are longer term initiatives that will happen over the course of years, not months.

JULIE HYMAN: So finally, I want to bring it back around to their earnings because you say in your note, looking ahead to the numbers, that you think China's sales fell 15% last quarter and that that could be too optimistic. Talk us through that and whether you think that's the biggest downside risk here.

CAMILO LYON: Sure, so if you recall last quarter that they reported, China sales were down about 25%. And the company guided to a sequential improvement quarter to quarter to quarter. So that means less negative as we proceed. And the company is able to advertise more and get better product into market. Now the contacts that we have in-market still are pointing to high heat product that's sitting on the shelf. So that, to us, suggests that the pace of improvement of our down 15 from what was down 25 the prior quarter could be too fast. So that's the downside of risk that we see to our numbers.

Again, I think a lot of this is due to the COVID one policy in China that really is restrictive and has hampered retail traffic into stores. And so that could be a very bumpy path to returning to growth. A lot of the things that we see as headwinds today for Nike and for the next quarter, so really don't start to turn into tailwinds until the back half of the year, China being one of those regions.

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