Nike‘s shares rose on Tuesday as the company’s fiscal second- quarter earnings sales beat expectations. But embedded in that report was less favorable news out of China, with supply-chain issues and Covid-related restrictions hitting sales—the latest yellow flag out of the world’s second largest economy.
In the near-term, China’s zero-tolerance policy toward Covid has led to stricter restrictions even as other parts of the world, including the U.S., have tried to avoid 2020-like lockdowns as Omicron hits.
Nike‘s (ticker: NKE) sales in greater China slipped 24% in the second quarter on a currency neutral basis, with the company citing inventory supply disruptions. Earnings before interest and tax margins in the region also contracted about 790 basis points from a year earlier, with the company noting inventory-related disruptions and a quarter of its partner retail stores and half of its factory stores in Greater China hit by local Covid-related mandates.
Chief Financial Officer Matthew Friend told analysts in a conference call on Monday that Nike expects fiscal 2022 to be a year of recovery and sequential improvements beginning in the third quarter.
Barron’s has previously highlighted the conundrum for large U.S. companies with big business in China, not just as the economy slows but as geopolitical tensions risk putting these companies in the crossfire between these two countries and China’s push to rely less on foreign suppliers drives more business to local options and feeds nationalism among consumers. Already, in the last couple of weeks, executives of large companies have had to gingerly walk around China-oriented comments with the additional scrutiny on the country’s human rights abuses in Xinjiang.
But in the call with analysts, Nike Chief Executive Officer John Donahoe responded to a question about local competition by emphasizing Nike’s record for taking a long-term view in China. Donahoe added that Nike is “going to continue to invest to lead in China,” adding that more of what Nike is doing in China is tailored to the Chinese consumer.
In the near-term though even analysts upbeat on Nike broadly are wary about its China business.
In a note to clients, Cowen analyst John Kernan said Nike’s trouble in China highlighted the volatility amid supply chain, macroeconomic and political forces in China facing the company—and peers like
Adidas (ADS:Germany). He also said improvement in China was uncertain, contributing to his below consensus earnings per share estimate for Nike for fiscal 2022 of $3.79, compared with the $3.56 a share the company reported in 2021.
Others are also wary: “While broader retail spending hasn’t fallen further, we’ve expected Chinese consumers to pull back spending on luxury goods and apparel,” Shehzad Qazi, managing director at China Beige Book, says via email. “With Omicron potentially adding additional pressure, the outlook for retail—and consumption overall—remains dull.”
That is not good news for companies with big business in China, nor necessarily for investors weighing whether to capitalize on the latest selloff in Chinese stocks, with the
iShares MSCI China
exchange-traded fund (MCHI) down 24% on the year.
BCA Research strategists are in the camp that this is a bargain worth passing up for now. They said in a recent note that Chinese technology, internet and growth companies aren’t cheap and are vulnerable to further derating. While some investors are encouraged by Chinese policymaker’s latest steps to support the economy, the BCA team doesn’t see stimulus creating a “decisive upturn” in the closely watched credit impulse—or a willingness to borrow.
That means Chinese and emerging market equities more broadly remain “in a risk window” for now, according to BCA strategists.
Write to Reshma Kapadia at [email protected]