A short recap
Since our last article titled “NIKE’s Position Remains Well-Entrenched” last October, NIKE (NYSE:NKE) stock price rose from $152 per share to $178 per share before falling to $143 per share ( as of January 21, 2022). In addition to the apprehension caused by possible earlier-than-expected interest rate hikes, retail sales which were significantly worse than expected – down 1.9% in December from an estimated decline of 0.1% – may have put additional pressure on the stock price. Still, the drop could present an opportunity for investors to buy NIKE at a lower price, in our view.
The hunger is still there
NIKE brand revenue grew at a 10-year CAGR of 9%, from US$18 billion in 2011 to US$42 billion in 2021 (please note that NIKE releases its fiscal year in May). Although management believed inventory supply would improve after FY22, NIKE is still going strong, posting 8.2% year-over-year brand revenue growth in the first half of fiscal 2022 – barely below its 10-year CAGR. In the third quarter, the company again waits revenue to grow in the low single digits.
North America revenue drove growth in the first half of fiscal 2022. On the 2Q22 earnings call, John Donahoe mentioned North American digital was driving strong holiday sales with nearly 40% growth, pushing NIKE Digital to 30% of the total North American market. Additionally, he discussed how the holiday season reflected NIKE’s global digital transformation and saw digital as a driver of the direct-to-consumer acceleration strategy.
We believe NIKE’s investments in its DTC and digital businesses will continue to drive long-term revenue growth and expand margins. According to management, the company has reduced its wholesale accounts in North America by 50% over the past four years and, in turn, has used NIKE Direct and its wholesale partners. Figure 4 shows that NIKE’s Direct earned 35% of its NIKE brand revenue, up from 23% in 2016.
Indeed, the figure shows that NIKE’s initiative across the Direct Consumer Infringement in 2017 to “get closer to the customer” has paid off. Additionally, the company launched the so-called direct consumer acceleration strategy in June 2020 to drive “investment in e-commerce and technology” and simplify its “consumer building of businesses for men, women and children”. , as cited in the Shoe News. Going forward, the company expects its DTC to reach 60% and be 50% digital by 2025, with NIKE-owned digital contributing 40% of the business.
More and more companies are turning to DTC channels. DTC, in general, offers higher margins than a wholesale business because DTC allows retailers to charge full price rather than discounts. Additionally, Retail Dive Noted that Under Armor (NYSE:UAA) is exiting thousands of wholesale channels. At the same time, adidas (OTCQX:ADDYY) aims to increase its DTC contribution to 50% of its turnover by 2025, channeling 1 billion euros towards digital transformation until 2025.
As a result, in the first half of 2022, NIKE recorded a gross profit margin of 46%, the highest since 2016, which management attributed to “full price realization and lower markdown rates.” Additionally, according to an analyst, NIKE was able to relay more about “newness and exclusive product drops” than a discount to drive “incremental sales,” as cited in Retail diving. The fact that the DTC business has made a larger percentage of annual revenue leads us to believe that the company’s plan to reach 40% gross profit margin seems achievable.
Additionally, NIKE acquired a consumer data analytics company Zodiac Inc. in 2018 to strengthen its relationships with its customers “through digital and physical consumer experiences”. To be a more data-driven company, NIKE also purchased Celect, a predictive analytics company, and Data log, a data integration platform startup, to “serve consumers more personally at scale.” Additionally, the SNKRS app led NIKE to improve its digital business (NIKE Digital accounted for 25% of total brand revenue in 2Q22) by delivering “personalized shopping offers” using data science to ” lead the digital targeting of members”. In our view, significantly improving the personalized shopping experience for customers could help the company drive long-term revenue growth.
Enter the Metaverse
Not only is it strengthening its physical presence, but NIKE’s plan moving forward is to become more digital as well. Being an early adopter, NIKE certainly doesn’t want to miss the opportunity to set foot in the metaverse. Last October, NIKE posted job openings for virtual design roles, including a virtual shoe material designer, as cited in CNBC. Next, NIKE created Nikeland, a virtual world featuring mini-games, in the Web2-powered Roblox. Finally, to use Web3 capabilities, which will allow NIKE to create a decentralized virtual world, NIKE announcement in December, that it acquired RTFKT for an undisclosed amount to “expand NIKE’s digital footprint and capabilities.”
How will building a presence in the metaverse improve NIKE’s finances in the long run? According to Forbes, NIKE can produce virtual samples, reducing the cost of manufacturing physical models. Additionally, at Nikeland, merchants and brands can “drive scalable consumer traffic to their products” and “offer a fully managed solution.” But the vision NIKE envisions is when people can enter VR spaces where things will materialize once the blockchain is authenticated, like The edge described on its website.
In other words, establishing a presence in the digital world could also boost NIKE’s sales as we move forward. Buying a virtual sneaker to wear in the digital world might not be the weirdest thing to hear in the future, especially after Meta (NASDAQ:FB) has a long-term vision to “build immersive worlds 360 degrees”, where people can access through virtual reality glasses, as quoted in CNBC. In fact, corporations and wealthy individuals are spending millions of dollars buying virtual land on popular metaverse worlds like Decentraland and Sandbox.
Additionally, the NFT royalty structure is lucrative, as the the wall street journal described such a structure as “worth exploring NFTs”. For example, unlike physical sneakers, for any sale and resale of virtual shoes and other products, RTFKT gets 10% of the discount, as cited in the same source. And the NFT market is just starting to take off.
Jefferies, an investment bank, made an optimistic forecast. The bank estimates that the market capitalization of NFT will reach more than US$35 billion by 2022 and rise to US$80 billion by 2025, cited in the CoinDesk. Another estimate from Grayscale suggests that the Metaverse market opportunity could reach $1 trillion in annual revenue. To capture this significant opportunity, retailers such as Under Armor and adidas released NFTs, “In the metaverse” and “Genesis Curry Flow“, respectively, which debuted last year. Their resale prices have skyrocketed ever since.
In our opinion, NIKE’s initiative to set foot in the metaverse is perhaps analogous to a search for treasure in an unknown world. In this high-risk journey, you can return home empty-handed or with highly lucrative rewards. In the latter case, however, a presence in the digital world could allow NIKE to cut costs by manufacturing virtual rather than physical samples. Second, NIKE could sell virtual sneakers when virtual reality became more widespread. Finally, fees for selling and reselling virtual sneakers, which could allow NIKE to monetize the resale market, could be a lucrative opportunity.
NIKE is trading at its 3-year +1STD, with a trailing 12-month P/E of 37x. In our previous article, we estimate that NIKE’s EPS will reach $5.9 per share by 2025, based on 2025 objectives. If we take the consensus EPS estimate of $3.7, that will imply a 3-year CAGR of 17% through FY2025, which is quite reasonable given the EPS growth target middle to tall teenagers. Our previous target price estimates range from $208 per share (up 46%) to $251 per share (up 76%).
Some might be against investing in NIKE due to its high multiples. Yet, we still believe NIKE’s long-term potential justifies its valuations. First, despite headwinds from inventory-related issues, NIKE has still managed to maintain revenue growth (estimated revenue growth for fiscal year 2022 is 6%). Second, NIKE’s efforts to improve its DTC business, which gives the company the flexibility to sell products at full price, have widened its margins. Additionally, significant investments in creating a more personalized customer experience could help the company drive long-term revenue growth. Finally, building a footprint in the digital world, especially as an early adopter, could be rewarding in the long run, furthering the company’s goal of becoming more digital.
Overall, we think NIKE’s investments in its DTC business and the metaverse to become more digital could pay off in the long run. If you have any ideas, feel free to comment below.