Nike Financial Analysis: FY2011 Performance and Investment Outlook

Financial Performance Overview

Nike earned a net income of $2.133 billion in fiscal year 2011 on revenues of $20.862 billion. A trend analysis of the income statement shows that revenues grew 9.7% in FY2011, while net income grew by 11.8%. In the previous year (FY2010), Nike's revenue actually declined by 0.8%, while net income increased by 28.2%. The performance over the past two years indicates that Nike faced some difficulty growing its revenues, but compensated with stronger cost controls. The common-size income statement reveals where these improvements occurred. The difference was not in the cost of sales, which ranged between 53.7% in FY2010 and 55.1% in FY2009. Rather, it was found in the company's "demand creation expense" (i.e., marketing), which fell from 12.3% of revenue in FY2010 to 11.7% in FY2011 — a difference of $118 million, which accounts for most of the improvement between the two years' net income figures. By controlling marketing costs, Nike was able to allow more of its revenue to trickle down to the bottom line.

The company's balance sheet reveals that Nike grew larger by 4% over FY2010 in terms of total assets. Plant, property, and equipment grew much faster than total assets, at a rate of 9.4%. There was a significant drop in the company's cash, from 21.3% of total assets to 13%. This was matched by increases in both accounts receivable and inventory, both of which represented a more important portion of the balance sheet in FY2011 than in the prior year. Nike's current liabilities grew from 23.3% of the balance sheet to 26.3%. The company's long-term debt, however, declined over the past year, from 3% of the balance sheet to 1.8%. The company's equity barely changed, in part because retained earnings fell as a percentage of total assets, from 42.2% to 38.6% in FY2011.

A trend analysis reveals that cash provided by operations spiked in FY2010 by 82%, only to fall back in FY2011 to a level just 4.3% above the FY2009 figure. The increase in inventories and accounts receivable was largely responsible for the reduction in operating cash flow. The ratio analysis provides further insight into these figures.

Nike's liquidity ratios are healthy. The company has a current ratio of 3.2 and a quick ratio of 2.2, both of which indicate strong liquidity (MSN Moneycentral, 2012). In FY2010, the current ratio was 3.25 and the quick ratio was 2.65. The decline in these ratios must be examined in the context of a broader trend, given that the absolute numbers remain very healthy. However, should this trend continue over the next year or two, there may come a point at which Nike's management needs to address the issue more seriously. For now, healthy liquidity ratios are noted. The company is also strong with respect to long-term solvency: the debt-to-equity ratio is 0.04, and interest coverage is 431 times. Nike's very low level of long-term debt contributes to excellent financial health.

The company's profit margins are generally healthy. Nike's gross margin is 43.8% and has averaged 45.2% over the past five years. The operating margin is 13% and the net margin is 9.7%. While all of the company's margins lag the industry average slightly, they are in line with Nike's own five-year averages. The fact that Nike has maintained its margins within a fairly narrow range over the past five years despite the global economic slowdown should be viewed as a positive sign.

In terms of management efficiency, Nike has a receivables turnover of 7.5 times, an inventory turnover of 4.5 times, and an asset turnover of 1.6 times (MSN Moneycentral, 2012). In the prior year, the company turned over its receivables 9.3 times, its inventory 4.3 times, and its assets 1.3 times. These figures indicate that Nike is carrying more receivables as a percentage of sales than it was the previous year. This warrants some concern if it becomes an ongoing trend. Typically, investors prefer to see that a company has control over its receivables. In this case, Nike's customers are stretching out their payment timelines, which does not bode well for future business relationships with those firms.

Nike's investment returns are generally positive, and in FY2011 they were higher than the company's five-year average. According to MSN Moneycentral (2012), the return on equity was 22.6%, the return on assets was 15.5%, and the return on capital was 20.1%. These figures are, however, all below industry peers, which is a point of concern for investors.

Revenue Analysis by Geography and Product

Overall, Nike demonstrates relatively strong financial performance. Liquidity is its greatest strength, and there are only a couple of areas of minor concern with no significant red flags. The most notable concern is the rapid increase in receivables, both as a percentage of sales and in terms of accounts receivable turnover. Ideally, Nike would be reducing its cash conversion cycle rather than lengthening it.

Nike divides its business segment reporting in two ways: by geography and by product type. By geography, Nike's biggest market is North America, which accounts for 41.8% of its business. Western Europe accounts for 21% of company revenues. The next two largest categories are "Emerging Markets," worth $2.7 billion (13.1% of revenue), and Greater China, which at $2.06 billion accounts for 9.8% of revenue. Central and Eastern Europe and Japan comprise smaller portions of Nike's revenues. The trends within the geographical breakdown are revealing. The fastest-growing region for Nike is Emerging Markets, with 24% year-over-year growth (2010 to 2011), followed by Greater China at 18%. The North American market grew at 13%. Japan, by contrast, fell by 13% in the year, and Western Europe declined by 2%.

Nike also provides product and regional breakdowns. In North America, apparel grew 21% and now accounts for 27.8% of revenue, while footwear accounts for 67.4% of revenue. This market, with 41.8% of sales, contributes 53.2% of Nike brand EBIT. Western Europe, the second-largest market, contributed 21.9% of EBIT — ranking it behind both Greater China and Emerging Markets. The Western Europe market is 33.2% apparel and 61% footwear.

In Greater China, apparel represents 38.3% of revenue and footwear 56.5%. In Emerging Markets, those figures are 24% and 69.3%, respectively. It is worth noting that with 13.1% of revenue, Emerging Markets contributes 20.9% of EBIT, while Greater China, with 9.8% of revenue, contributes 23.6% of EBIT.

In general, footwear carries a higher margin than apparel, so that regions with a greater proportion of footwear sales tend to outperform in EBIT contribution relative to revenues. Greater China is a notable exception, generating strong EBIT relative to its revenue share. The older, declining markets in Western Europe and Japan contribute less in EBIT terms than their revenue shares would suggest, and even the Central and Eastern Europe market showed an 8% decline in EBIT despite a 4% increase in revenue. North America continues to be the engine that drives Nike's business, but there is a compelling case for Greater China and Emerging Markets as the future of the company.

Gross Margin and Net Income Drivers

The gross margin declined from 46.3% in FY2010 to 45.6% in FY2011. Nike attributed this decline to "higher input costs across most businesses," "increased transportation costs including additional air freight costs," and a "lower mix of licensee revenue" within the "other businesses" category.

Net income, which grew at a faster rate than revenues, was affected by several factors. The gross margin decline worked against improved net income figures. The company saw its marketing expense fall by 4% in FY2011, which it attributed to the absence of a FIFA World Cup in 2011 — in contrast to 2010, when marketing spending was elevated. Operating overhead increased by 7%, but this was slower than the increase in revenues, resulting in a lower percentage of selling and administrative expenses in FY2011. Net income was also affected by restructuring charges, but these were minor in both FY2010 and FY2011 and were not a major factor in the year-over-year change.

Page 23 of the 2011 Form 10-K breaks down revenue in Greater China and Central and Eastern Europe; it does not outline the company's financial policies or overall strategy. The company outlines its strategy on page 17 as follows: "Our strategy is to achieve long-term revenue growth by creating innovative, 'must-have' products, building deep personal consumer connections with our brands, and delivering compelling retail presentation and experiences." The company also notes that its goal is "to deliver value to our shareholders by building a profitable global portfolio of branded apparel, footwear, equipment and accessories businesses."