Nike just tripped. Is it still a purchase?

We got used to slam dunks from Nike (NKE -12.81%). Even through most of the pandemic, Nike managed to grow revenue and profits. But two elements of the latest earnings report caused a strong reaction from investors. And it was not positive. The stock fell more than 12% in a single trading session.

The sportswear and footwear maker disappointed investors last week by reporting high inventory levels and a declining gross margin. Like many retailers, Nike faces higher costs and supply chain issues. And the challenges are not over. Given that, is this market leader still a buy? Let’s find out.

Gross margin drops

The bad news first. Nike struggled in two particular areas in the first quarter of fiscal 2023. We’ll talk about gross margin first. It fell 220 basis points to 44.3%.

One of the reasons behind this was rising transportation and logistics costs as a result of rising inflation which hurt businesses and consumers. The strengthening of the dollar also weighed on the gross margin. When the dollar gains against other currencies, Nike’s foreign earnings are worth less when brought home.

Markdowns to release additional inventory also hurt gross margin. And speaking of inventory, that was Nike’s second biggest issue in the quarter. Inventories increased by 44% compared to the prior year period. Transit time issues and an intentional decision to purchase items earlier were two factors that drove inventory up.

Nike says stocks in North America have likely peaked – and we should expect some improvement from here. It’s awesome. But things like rising inflation and a stronger dollar could linger for some time. The coronavirus situation remains a risk. Any spike in the infection rate could close factories or shutter stores in a key market, such as China.

So there is no guarantee that Nike’s gross margin or net income will recover overnight. But before that sounds too daunting, let’s get to the good news.

Brand strength

First of all, it is important to note that Nike’s problems are due to external and temporary problems. Economic conditions will improve, as they have in the past following downturns. Nike has the brand strength, strategy and overall financial health to keep pushing forward until the economic situation improves.

So let’s take a look at some of these positives. First, the strength of the brand. Nike continues to be a favorite brand in North America and China. And Nike’s Jordan brand reported its best year in the past fiscal year.

Nike’s strategy of selling direct to consumers and focusing on digital is working. The company launched the initiative in 2017. Digital business has nearly tripled since fiscal 2019 to $10 billion in revenue. During the first fiscal quarter, Nike’s digital revenue grew by double digits in North America, Europe, Asia and Latin America. And it was the highest revenue quarter ever for Nike Digital.

In terms of financial strength, Nike has a track record of growing profits, revenue, and free cash flow over time.

Net income NKE (annual) given by Y-Charts

During the last quarter, Nike reported $11.9 billion in cash, cash equivalents and short-term investments. That’s more than Nike’s long-term debt of $8.9 billion. This is positive as it shows that Nike has the cash to invest in its business and reward investors. Nike has increased its dividend payouts for 20 consecutive years.

Considering all of this, Nike shares are a steal today. They are trading at 27 times forward earnings estimates. That’s down from over 45 earlier this year. At the same time, revenues continue to rise.

Graph of NKE PE ratio (before)

NKE PE ratio (front) given by Y-Charts

Is Nike a buy? As mentioned, Nike’s problems may not be over – due to the current economic crisis. But Nike’s long-term image remains extremely bright. It is impossible to recover a stock at its very low indicate. That’s why it’s best to buy anytime the valuation looks attractive given the outlook for future earnings. For Nike, the moment is one of those moments.

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