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Nike: 'It's probably going to be a difficult Christmas' with inflation, analyst says

Morningstar Equity Analyst David Swartz examines Nike's stock following the athletic brand's first-quarter earnings beat, in addition to looking at the supply chain outlook against the fall holiday season and slowdowns in China.

Video Transcript

DAVE BRIGGS: Good stuff, Josh. Why don't you stick around while we talk to David Swartz, Morningstar equity analyst, joins us now to discuss these Nike earnings. Good to see you, sir. Big picture, your reaction, and why do you think the stock is down about 2%?

DAVID SWARTZ: I think the quarter was exactly in line with most expectations. $0.93 was what I had for EPS, and the revenues came in about 300 million higher than I expected. And the bottom line was almost exactly as I had projected. So there wasn't really anything in the quarter that was negative. Now the China sales were down 16%, but in my model, I had them down 20% So I actually thought the China number was a little bit better than expected, considering that's really been a sore spot for the company.

As for why the stock is reacting negatively, at this point, you know, I think people are focused on the fact that inventories were up quite a bit, 44%. And margins did take a hit. The gross margin missed my estimate by about 100 basis points. There were reports in the quarter that Nike had done a lot of discounting, and it told wholesale partners in North America that it could go below the minimum advertised pricing to try to move product.

SEANA SMITH: David, that gross margin stuck out to me, too, a decrease of 220 basis points to 44.3%. When we talk about supply chain issues that the company is facing, also a higher inflation, I guess, obviously, weighing on the consumer, when do we see that number begin to improve, do you think?

DAVID SWARTZ: I think it will start improving pretty soon. I mean, right now, if you look at shipping rates, they have fallen. Cargo container rates have fallen. You know, I think a lot of the input costs have declined. Obviously, energy, gas has declined. So has cotton. So we have seen a decline in a lot of input costs. And the supply chains are getting better. They are not at typical levels. But I think Nike will be able to get its product in faster.

Now it's probably going to be a difficult Christmas season this year. And Nike and others have projected that with inflation affecting consumer spending and the ongoing weakness in China. But, you know, I think it's generally improving.

RACHELLE AKUFFO: And David, obviously, on top of inflation, you have a very strong dollar, which has been a headache for some multinational companies. How do you see that impacting Nike going forward?

DAVID SWARTZ: It certainly does impact Nike, but it doesn't seem to have hurt them too much in this quarter, compared to some other companies that I cover with large international businesses. Nike does sell a lot of product in the countries where it produces the product. So that does reduce the impact somewhat.

But you look at the North America sales numbers. They're actually pretty good, and in other countries, too. Europe has held up pretty well. Nike's main problem has been China. And it hasn't really had to do with the currency so much as the COVID restrictions in the country.

DAVE BRIGGS: Many view, David, Nike as a real bellwether for the economy and for the sector. What does it tell you about what's coming?

DAVID SWARTZ: I think, right now, there's-- people are far more pessimistic than they really should be because I mean, we're seeing a lot of companies that are definitely suffering in the second half of the year, but their outlooks may be down for the next couple of quarters. But generally, demand for their products remains high.

We're seeing a lot of companies, especially international companies like Nike, that have large businesses in Europe that are being affected. Their stock prices are down quite a bit because people anticipate a major recession in Europe due to the war and the financial situation.

And then also, in North America, people are anticipating a recession. But if you look at the numbers, for the most part, the companies that I cover are not reporting the kind of numbers that suggest that there's going to be a major recession.

SEANA SMITH: David, when we take a look at the strong dollar, obviously, a huge headwind here for Nike. I guess, how big of a challenge do you see that being for the company in the current quarter?

DAVID SWARTZ: It's going to be a problem. I mean, there's nothing Nike can do about it. But, you know, I think I've seen other companies that have had more problems with it. So I think Nike seems to be handling it pretty well. I mean, the company still reported 4% sales growth in the quarter. And it would have been 10% constant currency, it looks like.

So, you know, it still generated sales growth, even with a significant headwind from the strong dollar. Many other companies right now have been reporting negative sales growth because of the dollar. So it does seem like Nike is getting through that situation better than most others.

RACHELLE AKUFFO: And David, with a lot of retailers still trying to figure out the consumer, some perhaps switching brand loyalty, going for cheaper brands, we don't seem to see that happening as much with Nike. What do you think is going to be the key for Nike going forward, as it clearly is still holding onto its customers?

DAVID SWARTZ: Yeah, I mean, Nike has a very strong brand. That's why we rated it as a wide moat company. We say it has a big competitive advantage because people do love Nike products. And they do sell a lot of them at very good prices. Now, Nike has had to do discounting. And that's probably going to continue at least for the next couple of quarters. But generally, I don't see them having to do a huge discounting.

And Nike should get a boost from the World Cup, which is coming up in a few weeks and as well as major sporting events, you know, which had hurt Nike during the pandemic when a lot of sporting events were shut down. But now they're really operating normally. And then the World Cup, generally, I think would be positive for the company.

SEANA SMITH: David Swartz, great to have you, Morningstar equity analyst. Thanks so much for joining us. Also, Josh and Dave both have-- both sporting their Nike shoes today.

DAVE BRIGGS: Of course.

SEANA SMITH: So maybe helping. I don't know when you guys bought them.

DAVE BRIGGS: Every day.

JOSH SCHWARTZ: My leg doesn't go up that high, Dave.