China concerns hobble Nike

Demand in the world's most populous country declines for the first time in three years, prompting the sports apparel maker to slash prices.

By Jonathan Berr Sep 28, 2012 12:50PM
Shares of Nike (NKE) opened sharply lower Friday morning as investors responded to news of declining sales in China. Although losses were pared by midday, investors remained concerned that a slowdown in the world's most populous country will hurt the sneaker and athletic apparel company. 

Net income at the Beaverton, Ore., company fell 12% to $5.67, or $1.23 per share, as expenses rose at a faster rate than sales. Revenue surged 10% to $ 6.7 billion. Analysts had expected profit of $1.12 on revenue of $6.42 billion, according to Reuters. Profit declined for the second straight quarter following 9 straight gains. There were many red flags to unsettle investors.
 
For one thing, gross margins declined 80 basis points to 43.5%. Selling and administrative expenses skyrocketed 18% to $2.2 billion while "demand creation expenses" spiked 29% to $891 million due to costs associated with the Olympics and the European Football Championships.

Then there's China -- where orders fell for the first time in three years. Not surprisingly, Nike CEO Mark Parker tried to give investors a positive spin about China during Thursday's earnings conference call: He has been slashing prices in China to clear out inventory, which has depressed demand for new products.

"I feel very good about our competitive position in China, and I'm confident in the enormous potential for our business in this market," he said. "At the same time, China is moving toward a more consumer-focused economy. Over the long term, we think this trend is good for Nike."

Over the short-term, the outlook for China is murky. Economists surveyed by Reuters expect Chinese economic growth to slow to 7.4% in the third quarter, its seventh straight drop-off, before hitting 7.4% in the last three months of the year. Experts are never quite sure whether to believe the official figures offered by the Communist state. If politicians in cashed-strapped Europe lied about their economies, it wouldn't be a stretch to envision it happening in China.

Lots of companies that benefited from the skyrocketing growth in China are now bracing for the slowdown. Some such as Yum Brands (YUM), parent of KFC and Taco Bell, and luxury goods retailer Tiffany & Co. (TIF) have already seen a drop-off in their China business. More such announcements are sure to follow.

Signs of social unrest in China are emerging as its middle class demands better pay so they can enjoy the fruits of capitalism, such as fancy sneakers. If the Chinese government can't prevent its economy from overheating, the results could be far more disastrous than a meltdown in Europe. That's why investors should be cautious when adding stocks with significant China exposure to their portfolios.

Jonathan Berr does not own shares of the listed stocks. Follow him on Twitter@jdberr.
 
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