The Silver Lining in Nike’s Weak Fiscal Q3 Earnings Report

Nike (NYSE:NKE) had some bad news for investors in the earnings report it delivered last week. The apparel giant’s global revenue took a surprising step backward after its rebound in the prior quarter. In its fiscal 2021 third quarter, which ended Feb. 28, sales fell by 1% — a jarring shift from the 7% increase that the company achieved in the period that ended in November.

Management described the slump, plus a related spike in inventory, as just a temporary problem driven by shipping issues rather than a slowdown caused by customers shifting to competing brands, or by weaker demand for its footwear and apparel. In fact, CEO John Donahoe and his team still expect to hit their aggressive fiscal 2021 targets.

There are at least three reasons investors should lend credence to that ambitious outlook.

A young woman jogging.

Image source: Getty Images.

1. China sales are booming

The Chinese market contributed a huge portion of Nike’s growth in 2019, but it was the first to fall during the initial COVID-19 outbreak in early 2020. But that important geography is back in full expansion mode today. Sales there jumped by 42% in fiscal Q3, accelerating from a 19% increase in the prior quarter.

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That spike offset sales declines in Europe, where new rounds of social restrictions meant to slow the surging spread of COVID-19 hindered retail. It also marked the second consecutive quarter during which the China division produced more than $2 billion in revenue. The company’s rebound there offers a great example for the path that it could take in other markets as the coronavirus threat fades.

2. The U.S. market is healthy

Investors just glancing at the U.S. segment might conclude that there’s been a brutal shift in domestic demand trends. Sales fell 11% after rising 1% in the prior quarter. Inventory levels soared 31%, too, which might normally signal a period of costly markdowns ahead.

But both of those metrics were driven down by shipping container shortages that delayed the flow of goods from overseas factories to domestic customers. Pricing and demand at retailers, in contrast, were strong as shoppers continued to snap up new launches across the footwear portfolio. Nike is predicting no lingering impact from the shipping issue on either sales or profits. “We expect to capture this delayed revenue in the fourth quarter,” Donahoe said in a call with investors.

3. Profitability is still rising

Despite the shipping issues, gross profit margin still jumped by 1.3 percentage points to 45.6% of sales this quarter. That’s strong evidence supporting management’s explanation that demand held up well in fiscal Q3 even though reported revenue fell.

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It’s also a sign of positive things to come since those rising margins are a consequence of the company’s continued shift toward direct digital sales. Nike’s e-commerce channel is more profitable for it than its wholesale channel, and that segment was booming in fiscal Q3, with sales rising 54%.

That strong digital growth is the main reason why management is estimating that gross profit margin will rise by 0.75 percentage points for the fiscal year — a bit more than it predicted back in mid-December. The upgraded outlook is a clear sign that Nike sees its weak third quarter as just a speed bump on the way to a full growth rebound. And the forecast gets brighter from there, with many years of profitability gains ahead as the company shifts its focus toward high-margin e-commerce sales.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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