Nike's massive opportunities in China and Brazil
The athletic footwear company seems poised to see continued margin expansion and the return of profitability.
The tide may have turned for Nike (NKE). The athletic footwear company seems poised to see continued margin expansion and the return of profitability in China over the next year.
Emboldened by recent success, management appears confident in the strength of its brand and its capacity to raise prices. Nike also has a double whammy of an opportunity in Brazil, with the coming World Cup in 2014 and the Olympics in 2016. The stock currently trades around $60 a share, but it could top $80 if things go their way, according to UBS ' equity research team.
Nike has zigzagged over the past year, its stock falling precipitously and surging dramatically on any indication that margins were set to either expand or compress. After its latest earnings report, where the company revealed margin expansion for the first time in two years, Wall Street has once again gone bullish.
In a thorough note released Monday, UBS' Michael Binetti made the case for buying the stock, expecting solid returns over the next two years. After meeting with management, Binetti spoke of a "very optimistic top line outlook from the company over the next few years," pointing at "a deep innovation pipeline in premium footwear."
Nike appears better positioned than its rivals to raise prices, which have essentially remained stuck in a "deflationary environment for a decade." Recent earnings releases reveal management has been experimenting with price increases, and these have worked, according to Binetti. "We think the company has renewed confidence in its pricing power, particularly with its pinnacle/most innovative products," explained the analyst.
That point is key. Nike should be able to deliver approximately a 3% increase in year-over-year prices over the next few years, which should help gross margin improve. With materials and labor costs set to continue rising, Nike's management is ready to tackle the problem head on. The company has been innovating with lower cost methods of production (they are even testing 3D printed soles) and is "investing heavily to be the first to market with lower cost sourcing options."
At the same time, growth should return to China, where Nike has been trying to get its act together over the past several quarters. They have stopped inefficient unit growth, even closing stores, and are investing to improve distribution, IT capabilities and their factory outlet system. In their fiscal third quarter, the company revealed future orders returned to positive growth and grow margin increased. Nike is setting itself up for a return to double-digit growth in China, possibly by the end of fiscal 2014, Binetti said.
This leads to Nike's other major opportunity: Brazil. The largest Latin American economy will host two of the world's major sporting events over the next few years. Nike will be able to capitalize on its strength in soccer during the 2014 Fifa World Cup, and then target audiences across a variety of sports during the 2016 Olympics in Rio.
Shares in Nike have done well in 2013. The stock is up nearly 18% this year, just above Under Armor and well ahead Foot Locker, which has traded roughly flat. The company named after the Greek goddess of victory could see its earnings per share grow up to 23% in an ideal situation, taking its shares north of $80 in 12 months, according to Binetti.
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