Average selling price increases across most categories, improved basketball sales, and strong top-line momentum in China and other emerging markets suggest the wide-moat brand retains its dominance.
While tepid futures orders, gross margin compression, and higher inventory levels are in focus after Nike
's second-quarter update, we continue to see signs of a strong brand intangible asset, the key source behind our wide moat rating. In our view, average selling prices increases across most categories, improved basketball sales, and strong top-line momentum in China and other emerging markets suggest the brand remains on solid footing and helped to drive second-quarter revenue and EPS ahead of expectations. More importantly, we believe Nike is taking steps to accommodate evolving consumer views regarding personalization and technology, most notably through enhancements that cut down prototype production (with clear speed-to-market and cost optimization benefits) and mobile app refinements. In our view, these efforts will drive future demand and pricing power, and support our five-year outlook calling for average annual revenue growth of 10% and operating margins pushing 19% (versus expectations of 14% in fiscal 2017). Altogether, we're not planning material changes to our $57 fair value estimate, and we view shares as modestly undervalued.
R.J. Hottovy, CFA, is a consumer strategist for Morningstar.
Admittedly, a 2% increase in futures orders was weaker than anticipated. While competition from Adidas/Under Armour and the trend shift toward lifestyle fashion versus performance products played a part, we continue to believe that Nike's expanded direct-to-consumer capabilities (constant-currency DTC revenue increased 25%--including 11% comps at Nike stores--which also explains the 9% increase in inventories) have diminished the correlation between futures orders and revenue. As such, we still find full-year guidance calling for high-single-digit top-line growth achievable. Management attributed gross margin pressures to higher product costs, foreign currency, and a higher mix of off-price goods due to retailer consolidation, but we expect the product cost and off-price mix issues to subside as the year progresses.
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