3 Surprises in Nike's Third-Quarter Earnings Report

MarketsMotley Fool

Heading into last week's earnings release, investors were optimistic that Nike (NYSE: NKE) would have good news to report. After all, the sports apparel giant hinted three months ago that the second half of its fiscal year might bring an end to the sales declines in the U.S. market that have reduced profitability and slowed global growth over the last two years.

On Thursday, the company confirmed that rebound forecast in its most concrete terms yet. The retailer had a few other pleasant surprises for shareholders, too.

Continue Reading Below

Let's take a closer look.

Stabilization in the U.S. business

The U.S. segment contracted by 6% for a slight worsening of sales trends from the prior quarter's 5% decline. However, looking beyond that headline number, Nike executives noted sharply improving trends toward the end of the quarter. The direct-to-consumer business posted healthy growth thanks to a huge influx of new product releases, they said. Meanwhile, Nike believes it has finally worked through all of the slow-moving inventory that had built up in its retailing network. "We now see a significant reversal of trend in North America," CEO Mark Parker said.

Investors saw early evidence of that success in a gross profit margin that, by shrinking less than 1%, beat expectations. The 0.7% decline marked the second straight quarter of an improving trend on this metric, in fact. Gross margin slipped by 1.2% last quarter and by 1.8% in fiscal Q1.

The improving demand trends and stronger inventory position led management to predict an imminent rebound to its struggling U.S. business. The segment should be flat in the next quarter before returning to growth in the first half of fiscal 2019, they said.

Faster growth in China

Nike gets more than half of its revenue from markets outside of the U.S., giving it a nice advantage over Under Armour (NYSE: UA) (NYSE: UAA), which depends on the U.S. for about 80% of its business. The China market is particularly important to its long-run growth plans since Nike expects that country to grow to many multiples of the U.S. over the next few years.

That's why it was good news to see China's sales growth speed up to a 19% pace this quarter from 15% in the prior quarter. Profitability shot higher there, too, as earnings improved 30%. Parker and his team believe those numbers could continue accelerating as Nike launches more innovative products and rolls out its digital loyalty program, NikePlus.

Doubling down on an aggressive outlook

Nike issued a long-term operating outlook in late October that envisioned significantly faster sales growth than investors have witnessed over the last two years. Executives also predicted a return to improving profitability through 2020.

Its fiscal second-quarter results from late in 2017 contained no real progress on either of those metrics, but Nike's latest trends paint a more encouraging picture. Thus, while Nike won't issue its fiscal 2019 outlook until next quarter, management felt confident enough to make a few comments about that period. In a conference call, they said to expect "strong" gains in gross margin for the year, healthy growth in international markets, and a return to sales increases in the U.S.

Nike has been making similar-sounding predictions for several months. The difference this time is that sales and profitability metrics are moving in the right direction even as the company floods the market with new releases aimed at accelerating those positive trends. In other words, Nike's rebound is finally hitting its stride.

10 stocks we like better than NikeWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Nike wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of March 5, 2018

Demitrios Kalogeropoulos owns shares of Nike and Under Armour (A and C shares). The Motley Fool owns shares of and recommends Nike and Under Armour (A and C shares). The Motley Fool has a disclosure policy.