Nike faces ‘unprecedented macro headwinds’, analyst says

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John Kernan, Cowen’s Managing Director for Retail and Consumer Brands, joins Yahoo Finance Live to discuss retail trends and outlook for brands including Nike, Gap and Yeezy.

Video transcript

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SEANA SMITH: Okay, Kanye West is stepping away from corporate America, telling Bloomberg it’s time for him to, quote-unquote, “go it alone” after his current contracts expire. Now the rapper is tied to Adidas until 2026 and Gap until 2030.

Joining us now to find out more about it, we want to bring in John Kernan. He is Managing Director of Cowan Retail Consumer and Consumer Brands. John, good to see you. So Adidas and Gap are both really big bets on Kanye. Of course, there’s been a lot of drama here between Kanye West and the two brands. You cover Adidas. What does this mean for the brand?

JOHN KERNAN: Well, we believe the Yeezy brand for Adidas generates at least over $1 billion in revenue. And they pay Kanye a big royalty for his business. I think, you know, when you look at the structure of the contract, it runs until 2026. Adidas is also looking for a new CEO in 2023. So there’s a lot of uncertainty with that company and this brand right now.

You see the stock at a multi-year low. When you think about what Yeezy means to the company, it’s, like we said, over $1 billion in sales. It’s probably over $100 billion in EBIT, a big chunk of their business. They provide distribution, execution and production.

So they don’t design the product. Kanye designs the product. But Adidas is really behind the distribution, production and fulfillment of this product. So hard to see how he’s going to go it alone in a very quick way. But it certainly poses a risk for him to not fit in with Adidas’ corporate structure.

Yeah, guess how he could go it alone without this massive infrastructure from a company like Adidas?

JOHN KERNAN: Well, he could try to find a new partner. He’s definitely under contract until 2026, so I don’t think he’s going anywhere anytime soon. But, again, it’s a very fluid situation. There is a lot of uncertainty about the long-term relationship. And, unfortunately, it’s a pretty big part of Adidas’ overall financial model.

SEANA SMITH: It could be a huge headwind here for Adidas going forward. John, I know you’ve been doing back-to-school checks, looking at the numbers just in terms of demand, some of the consumer trends. Just what do you see in terms of what people are willing to spend on retail and where they are spending?

JOHN KERNAN: Yes, of course, it is a bifurcated consumer environment. We have seen the strength of the high-income consumer. We’ve seen a lot of pressure and downward trade among low-income consumers. In athletic footwear and apparel right now, Lululemon is really leading the way with its product cycle, seeing it report revenue up 29% year-over-year in the last quarter. , raised its forecast quite significantly. There aren’t many other companies in my industry space that are on the verge of increasing the guidelines.

So Lululemon stands out, excellent cycle of products for men and women. Others we’ve seen have become much more promotional. And it’s really because the low- and middle-income consumer is under strong inflationary pressures.

How are companies like Nike and Adidas impacted by this environment?

JOHN KERNAN: Well, inventory levels in North America are very, very high. Nike’s overall inventory dollars in North America grew 44% in its most recent quarter. They will report again in two weeks, on September 29. I think inventory levels will remain high. We’ve seen this in the channel translate into very strong apparel promotions across the industry. And whether it’s Nike, Adidas, Under Armour, everyone’s been a bit more promotional lately.

SEANA SMITH: John, you recently lowered your price target on Nike to $124 from $127, so it’s not a huge down move, but still lower here towards earnings. Why are you, I guess, maybe not as optimistic — I don’t even know if you can technically say this — as you once were — because you still have that outperformance rating.

JOHN KERNAN: Yes, Nike’s valuation has certainly contracted a bit from the highs reached last summer. Earnings estimates have recently come under pressure from FX. That was really the rationale for our lowering of our sales and EPS estimates in the first quarter earnings that they’re going to release on September 29th. Look, the long-term history of Nike, the long-term margin expansion, the move to DTC, the move to e-commerce creates huge long-term earnings growth.

But in the short term, they face unprecedented macroeconomic headwinds, inventory levels, currency movements, a European consumer who is now under incredible pressure. So I think when you look at what they’ve already released for the full year, I don’t think they’re going to be likely to change that much. They must certainly resume their guidance in the face of the wind.

So that probably puts a bit of pressure on the consensus estimates. I think they will probably reiterate their full year sales guidance and full year EPS guidance. But, at the end of the day, they have to rain down expectations for the hit they’re going to take from FX.

John, you mentioned the European consumer. Looks like they’re on the edge of a recession. Who is most exposed to Europe and what impact will it have on them?

JOHN KERNAN: Yes, of course, in my coverage list, Nike, Adidas and Puma maintain the most exposure. Since both Puma and Adidas are based in Europe, they do more than a third of their business in Europe. Nike is a high rate of 20% and more. Look, the consumer is under pressure there.

The cost of doing business will also increase significantly, the cost of electricity and energy, stores, DCs, office buildings will all cost significantly more to operate. So everyone is under pressure in Europe. Everyone expects a recession. Certainly some of the contraction in valuations we’ve seen over the last six to nine months in this sector reflects that. But it’s a very difficult financial modeling environment. And the earnings that we model for next year, that’s pretty tricky.

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