Chief Investment Strategist
Nike started in 1964 as a simple retailer called Blue Ribbon Sports by Bill Bowerman and Phil Knight selling Japanese shoes from Onitsuka Tiger later known as ASICS. In 1971, the company rebranded itself to Nike and created the iconic “Swoosh” logo. A year later, Nike introduced its first own production footwear deputing in key track and field trials. In the late 1970s, the company expands internationally and also launches air cushioning technology before signing in 1984 the pivotal deal with basketball rookie Michael Jordan to endorse its air cushioning shoes through its Air Jordan line. This becomes a cultural phenomenon and puts Nike on the consumer’s mind in a big way.
In the 1990s, Nike expanded its retail concept with the first Niketown retail store and in 1996 the company launched its first global advertising campaign under the slogan “Just Do It”, which has become one of the most iconic marketing slogans in history. Everything was not rosy in the 1990s, as Nike was accused of bad labour practices in its overseas factories. In 2003, Nike acquired Converse expanding into more fashion-like categories. In 2006, it launched Nike+, a partnership with Apple, connecting footwear with iPod technology to track running performance.
Nike’s innovation continued with its 2012 introduction of the “Flyknit” technology which is an unique shoe material that reduces waste by knitting the upper part of the shoe in one piece. Over the past 10 years, Nike has leaned into the sustainability agenda with its “Move to Zero” campaign in 2015, and in 2018 it leaned into the political debate when it featured Colin Kaepernick, a former NFL player known for his social justice activism, in an ad campaign. Nike was already ahead of the competition on digital sales and the Covid-19 pandemic accelerated Nike’s commitment to its digital channel. In 2024, the narrative seems to have gone from flawless execution and must own brand to that of lack of innovation and failed omnichannel strategy.
Nike is a $51.4bn revenue company in athletic footwear and sports apparel. Nike is the market leader with revenue twice that of its competitor Adidas. Nike’s largest segment is the footwear division with 68% of revenue encompassing a wide range of sports and lifestyle shoes. The key brands are Air Max, Air Force 1, and the Jordan brand. The other main division is its apparel with 28% of revenue and includes apparel across sports such as running, basketball, and football. The equipment division is only 4% of revenue and includes everything from sports balls, digital devices, and general equipment for athletic performance.
When we look at the revenue split on regions it is dominated by its North America segment with 43% of revenue which is not necessarily unusual given it is Nike’s home market. But the worrying part is the falling revenue share of its Asia Pacific & Latin America segment since 2018. This segment features many countries with a growing middle class and strong compounding effects in their economies. This segment should be a big growth engine for Nike.
Another troubling fact about Nike is that its men’s collections are selling $20.9bn compared to $8.6bn across its women’s collections suggesting a company that missed the balance in its business and potentially lost the women category. Lululemon which is selling mainly to women delivered $9.8bn in revenue in the last 12 months and is growing much faster than Nike’s women’s collection. Lululemon’s revenue growth is expected at 12% in the current fiscal year compared to -4% for Nike.
Nike’s distribution is split between wholesale (retail partners) and NIKE Direct (online) with wholesale being 56% of revenue and NIKE Direct 44% of revenue. One of the recent problems for Nike and one of the key factors behind the falling share price is Nike’s bet on its direct channel alienating its wholesale channels. In April, the CEO admitted that their direct distribution strategy had gone too far. Direct business is good for margins, but the lower main wholesale business is good for brand awareness and distribution in new markets.
Reading this you might be wondering why we feature Nike as a quality company when they clearly has made some strategic mistakes. Nike is still a high quality company which will be obvious in our 7 powers analysis and the featuring of its quality characteristics based on fundamental data. With the latest setback in its share price it might be one of the most interesting turnaround cases in US equities.
The 7 Powers framework is a good framework to evaluate the sustainable competitive advantages of a company, providing an understanding of the factors contributing to a company’s market dominance. The 7 Powers framework, developed by Hamilton Helmer, includes scale economies, network economies, counter-positioning, switching costs, branding, cornered resource, and process power. Here is a short but not complete analysis of Nike through this lens:
Despite its recent troubles, Nike’s history says that the company is a high quality company that has grown its revenue by 7% annualised since 2009 and maintained its market leading position. Historically, Nike has been very well run in terms of stable operating margin and an interesting growth profile. But supply chain issues since 2018 and the pandemic has eroded its previous stability and the company has clearly missed strategic boats when it comes to women and high growth markets such as Latin America and Asia Pacific.
Nike’s EBIT margin ended at 12.3% in FY24 which is below its margin levels from FY10 to FY19. While currently a weakness it is also here the upside lies. If Nike can fix its supply chain and distribution then it can maybe push EBIT margin back to the 13.5-14% range and unlock significant shareholder value.
As readers of our previous notes on quality companies will know we believe return on invested capital (ROIC) is an important measure of quality. In its FY24, Nike delivered a ROIC of 24.5% which is very high and easily puts Nike in the top 20% of companies globally on delivering high returns on its capital. As the chart below shows, its weighted average cost of capital (WACC) is around 10%, so even with its recent setbacks, Nike is a high quality company that delivers shareholder value.
A good and simple yardstick for quality is outperformance relative to global equities. Nike delivered significant outperformance for decades and from mid-2014 to late 2021 the stock was a champion of the market. Since then the stock is down 54% and the stock has now underperformed global equities over the past 10 years. Nike shares are up 118% compared to 144% for the MSCI World over the same period. The share price performance shows why Nike has become an interesting investment case to consider for investors. If Nike can execute on improving its EBIT margin, fix its distribution channels, improve its brand, and regain relevance with women then Nike may return to a strong stock market performer again.
There are always many different risks to consider as an investor. In Nike’s case, we believe there are four key risks to consider.
Quality companies can be defined in many different ways just like value. MSCI, which is world’s largest equity index provider, has defined it using three fundamental variables return on equity, debt to equity, and earnings variability. This definition makes sense because it can be applied to all companies regardless of which sector they are part of. The definition puts emphasis on profitability relative to the deployed equity, leverage ratio (less debt leverage relative to equity is good), and finally the predictability of the business with less variance in earnings being a good thing. In our past equity research we have also found that the lower earnings variability a company has the higher its valuation becomes, so this is a quality marker.
In our equity research note Top quality companies and how to decode their traits we focused on return on invested capital (ROIC) relative to the cost of capital (WACC) as the key measure to identify quality. Next we explained, that around half of those companies with the highest ROIC see their ROIC falling from the top to outside the top over three years due to competition or changing technologies. This is the quality trap that investors need to avoid. It is about finding enduring quality. The “7 Powers” framework is a good approach to analyse whether a company has enduring characteristics or not. Finally, a company can have a stable spread in ROIC minus WACC with a ROIC not in the absolute top and still be a phenomenal stock for shareholders. All it requires is that the business can invest a lot into the business. Historically, Walmart was exactly such a case.
The interesting thing about researching quality companies is that you cannot put it all into a formula. You must apply discretionary thinking about the business, its products, the company’s strategy, the industry drivers, technologies strengthening or weakening the business, because in the end the big returns about changes in expectations for the company.
The list below highlights our previous analyses of quality companies.
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