Tom's Take: Nike Q1 Results

Let’s dive into, Nike.

?? Products

Their sneakers are worn by presidents, pole vaulters & everyone in between. Yet Nike doesn’t come with status. They are one of the world’s most recognisable brands & 2024 marked their 50th year in business.

So, to learn how Nike makes money, you need to understand two things; their products (what they are selling) and their distribution channels (where they sell their goods).

A brilliant product without distribution, well, it just sits on the factory floor. In fact, the general consensus is that distribution is more important than product. This is very significant & we’ll discuss it in a moment.

For now though, let’s start with products.

Nike splits their products into 3 categories: Footwear, Apparel & Equipment. The also own Converse, but for the sake of this analysis, we’ll leave that to one side.

Footwear is Nike’s largest source of revenue and in the last 3 months, they sold 26 pairs of sneakers per second, delivering sales of $7.46 billion. Their apparel department is responsible for ~30% of revenues generating $3b in sales. Lastly, their equipment department which includes everything from dumbbells to tennis balls generated over $600m in revenue.

Now, here is an example of how numbers can be deceiving.

Below is Nike’s Revenue Growth per sector over the last 5 years. [Put simply, how much more products they sold compared to the previous year].

What do you think?

On the surface, things appear to be moving in the right direction, lots of nice big numbers (despite the covid impact of 2020).

However, for a company at Nike’s scale, we need to dig a little deeper. A better way to analyse this is to look at the growth rate changes over time.

In other words, trying to see if Nike are growing faster than the previous year, or at least at a consistent rate. This type of analysis tells us much more; Are customers consistently buying? Are Nike growing their market share? Are their product team developing things that really customers want?

So, let’s look at the graph below which shows you the changes in growth rate over 5 years. What are the lines telling us? [hint: it’s not great]

Looking at footwear (the blue line), we see an initial increase in growth rate between 2020 & 2021, remember Covid closed retail stores during this period, so a bounce back was inevitable. However, we see a sharp decrease in growth rate, a brief increase before another sharp decrease. To me, this instability is a worry & indicates a number of potential issues: product saturation (How many pairs of Air Force 1s is enough?), new entrants stealing market share (On running reported a 30% sales increase) & little product innovation (Nike recently shut down it’s app for self-lacing sneakers).

Like footwear, apparel (orange) sees a Covid bounce back but has since been consistently declining YOY [year over year]. This suggests a maturation in the market, usually a result of a lack of product innovation.

Unfortunately for Nike, the golden child is their lowest revenue driver. Equipment has shown consistent growth despite Nike spending $1bn on virtual footwear & clothing studio called RTFKT in the NFT era. Go figure.

Our takeaway here is that although revenue is growing, it’s not consistent & ultimately hints a number of interesting trends. We’ve already referenced potential challenges around product innovation and market saturation, but these can often be outcomes of more pressing issues, usually visible in an income statement.

So, what exactly is an income statement?

An income statement is simple way to identify if a company is actually making any money from all their sales. It’s calculated the same way you might do your own budget:

Nike’s income statement over the last 5 years looks like this. And yes those figures are billions.

If we start to compare numbers, we see some issues. Essentially, poor management of their operations.

For example, between 2022 and 2023, although revenue grew by 10%, Nike actually made less profit. In this period, Cost of sales increased disproportionately to revenue (the red circle). In other words, Nike made less money per product than the previous year by not managing costs.

This gets even worse when you compare 2022 to 2024. Nike generated ~$5b more in revenue in 2024 but made ~$350m less profit (the red boxes). Selling more actually cost Nike money.

This is a rare sighting of diseconomies of scale [where a business expands so much that cost per unit increases]. This naturally is a particularly bad sign for a company of Nike’s size but more importantly, length of time in business.

For you & I, this would often be referred to as lifestyle creep. You get a new job which usually means a bigger salary. But, at the end of the year, you haven’t saved anymore money than usual. In reality, you’ve gotten used to a higher quality of life. More taxis, less buses. Nicer restaurants & better clothes. You haven’t effectively managed your costs. Tut tut.

?? Distribution

Ok let’s get into it. Distribution.

When we talk about distribution, we are essentially talking about routes to market. The different ways a company get’s it’s products into the hands of customers.

Almost all apparel companies have two channels to selling, wholesale & direct.

Wholesale refers to selling your products through stores. This is the farmer selling via Tesco, a makeup brand company via a pharmacy or an apparel company via Macys. These relationships are valuable to manufacturers like Nike because wholesalers will typically pay for all products they order (even if they don’t sell them), they are responsible for returns and require much less admin issues.

Direct, as it sounds, is selling via your own branded stores, mobile apps or website.

For years, Nike sold the majority of it’s products via wholesale partners. Companies like Foot Locker, Macys, JD Sports & more accounted for ~65% of Nike’s revenue.

However, in 2020, this all changed.

Under a new CEO, Nike announced a new strategy called Consumer Direct Acceleration. In other words, they were switching their focus to direct channels. Immediately, they cut ties with 9 of their largest wholesale partners.

At the time DTC (selling direct to consumer) had become very popular, naturally accelerated by Covid. Lots of us will have order home pizza kits, signed up to supplement subscriptions or maybe even meat delivery services like Butcher Box (which generated more than $600m in sales last year).

DTC presents an attractive proposition for a number of reasons:

o Data: By owning the customer relationship, DTC brands also own the customer data, enabling them to better understand the customer. The sizes the buy, colours, flavours, website visits, app opens & lots more. [This is why Under Armour paid $475m for MyFitnessPal, although that didn’t exactly workout. Pun intended.]

o ARPU: Average revenue per user is a fancy way of saying average sales per customer. Typically, DTC brands have a higher ARPU because of personalisation. They know you (via your data) so it’s easier for them to serve you products you’ll like and so you spend more.

o Margin: Remember, this is the difference between the cost to manufacture a product & the price a customer pays. Selling direct to a customer means you don’t have to give a discount or a portion of the sale to a retailer like Foot Locker.

So, Nike leaned in. Hard.

They began to push exclusive product drops on their apps like SNKRS. They let you create your own sneaker on their websites and they even created a suite of training apps to capture more data to serve you more personalised offers.

And right from the beginning, it worked. Revenue jumped, profit increased & Nike recorded it’s highest ever share price in 2022. [Remember, a company’s share price represents the value that public put on it, in other words, the amount they are willing to pay for a piece of the company.]

This graph shows you that growth, with DTC now representing almost 50% of Nike’s total sales.

So, why has Nike fired the CEO who brought in this focus & replaced him with someone who has come out of retirement, albeit someone who started as an intern at Nike?

Well, for starters, as we learned earlier, measuring growth rate over time is a more effective way to evaluate numbers & from the graph, it’s clear this has plateaued. About 1.5% growth for the last 3 years.

In this quarter’s filings, direct sales declined 13%, falling faster than overall sales of 10%. This is on the back of an 8% decline last quarter.

Most interestingly, Nike’s digital sales fell by 13% on the back of a 7% fall last quarter. Their shift to digital is no longer delivering. Customers have returned to normal shopping trends & are back in stores. Walmart foot traffic rose 22.2% compared to this time last year. This is bad news for Nike.

But Nike have already began to stop the bleeding.

They’ve opened new stores & have been re-listing with their largest wholesale partners. Looking at the last 4 years, we can see the changes.

Wholesale is growing & direct is falling at an almost identical rate of ~2%. This gap will likely extend as Nike benefits from less headaches from DTC.

????Tom’s Take:

So, what does this all mean for Nike?

Well, Nike still remains one of the most valuable brands in the world & it’s revenues are almost double that of Adidas [although the samba craze has led to them reporting a stronger than expected Q3].

Nike have certainly learned their lesson the hard way. The company’s market cap [the value of all their shares at current market price] is more than half what is was in 2021, dropping from $263b to $124b today.

There is a lesson here. If it ain’t broke, don’t break it.

Nike have always been pioneers in customer experience but pushed the boat out too far. Still, at the heart of the company is a brand with deep consumer connections, a network of loyal wholesale partners & an executive team who won’t make the same mistake twice.

Now, there is a question around their ageing flagship athletes.

Serena Williams no longer plays tennis.

Tiger Woods has launched his own (awful) clothing brand.

Lebron James is surely on his final season.

Cristiano Ronaldo is a cod.

Y’know what, we’ll leave that for another day.

??One Last Thing

It takes about 2 weeks to research & write these deep dives. And I love doing them.

But I need your help.

Got a company in mind you’d like to learn about? Let me know in the comments.

Until next time.