Joseph Taylor: David, thank you so much for talking to me about Nike shares today. It's been a poor year for the shares so far, down roughly 30% year-to-date. What's behind this?

David Swartz: Sportswear demand in North America, China and Western Europe has generally been disappointing this year and is not likely to improve very much in the second half of the year. Economic conditions have been less than ideal, especially in China, which is expected to be a fast-growing market for sportswear. Apart from the economic issues, Nike has been facing problems with its products, distribution and management. The company has seemingly fallen behind on product innovation, which has allowed competitors like On and Hoka to gain share in running and lifestyle shoes. While Nike has many new products coming out over the next year, investors are concerned that they may not be as innovative enough to compete with the new competition that it faces. Adding to Nike's problems that its direct-to-consumer strategy is not working as well as hoped. Nike has dropped many retail outlets in the last few years to focus on its own stores and e-commerce. However, it looks like Nike pulled out of too many stores and is now returning to some of them.

Taylor: So, the shares were especially weak after the earnings call. What did investors dislike about that in particular?

Swartz: The most disappointing part of the earnings report in June was the poor outlook that was provided. Nike guided to a mid-single-digit sales decline for fiscal year 2025, including a 10% drop in the fiscal first quarter. We had expected 1% sales growth in fiscal 2025 after a poor fiscal 2024, in which Nike sales were flat. Investors are concerned that Nike has fallen into a prolonged slump.

Taylor: So perhaps the closest comp is adidas, and their shares have actually been very strong so far this year, up around 25%. So, what accounts for this divergence?

Swartz: adidas' stock fell sharply in 2022 as its results deteriorated badly. It's all I can sense improved due in part to the popularity of its Terrex-style shoes. These shoes have been around for decades but have recently come back into fashion in Western Europe and North America. Nike also makes these styles of shoes, but its focus on performance sportswear has been a problem. adidas has also benefited from sales of its discontinued Yeezy merchandise, which has become more profitable than expected. We think adidas' stock is quite overvalued at present.

Taylor: Okay. So, bringing things back to Nike and looking beyond the share price a bit, is the company's moat still intact?

Swartz: Yes, we still believe that Nike is a wide moat company. Nike has a lot of advantages in terms of visibility, product development, and distribution. It is a global business with number one market share in sportswear in most of the major countries in the world. Despite its recent problems, Nike is still very strong in basketball, running shoes and in many other areas. It is the only sportswear company that we currently rate as wide moat.

Taylor: And is the opportunity in China and other emerging market economies still there?

Swartz: Yes, Nike has great opportunities in China and other developing nations. China is already the second largest sportswear company in the world after the United States, but still has tremendous growth potential. Millions of Chinese consumers are moving into the middle class and sports are growing rapidly in the nation due to heavy investment by the Chinese government. Nike also has opportunities in other parts of Asia such as India where incomes are rising. In the long run, Nike could build a large business in Africa, which has a very young population where the brand is already well known.

Taylor: And you mentioned earlier that the direct-to-consumer strategy hasn't worked as well so far as investors were hoping. What impact could this have in the medium term?

Swartz: Nike's shift to the direct-to-consumer channel could potentially allow for higher gross and operating margins. The company's gross margins have been in the low-40s, but we think that they can grow to close to 50% as it moves away from wholesale and does more selling through its own channels. The benefits of a direct-to-consumer strategy include better control over advertising and pricing, and higher rates of full price sell-through. In its wholesale business, Nike must share profits with its partners. Also, the company may be able to reduce its dependence on department and sporting goods stores, some of which have been in decline for many years. Lululemon is an example of a company that has achieved higher profits through a direct-to-consumer sportswear selling model.

Taylor: Great. And if investors are looking forward a few years, what are the two or three key factors that are going to affect the stock from here?

Swartz: Key factors for Nike to get better results include compelling product releases, improving demand for sportswear and shine in other regions, and cost efficiency efforts. By fiscal year 2026, we think Nike can get back to sales growth as demand in its markets improves and as its new products drive sales. Meanwhile, cost cuts should improve its profitability. We think Nike is very undervalued relative to our fair value estimate of US$124. Historically, investing in Nike during down periods like the current one has been a good strategy. One benefit of the decline in Nike's stock price is that it will be able to execute billions of dollars of share repurchases at lower prices than before.

Taylor: Great. So, the takeaway is that the shares have been very weak, but this could actually spell a long-term opportunity.

Swartz: Yes, I think so. And traditionally, for investors who bought Nike when it was down and held it for years, it has been a winning investment.

Taylor: Great. Well, thank you very much, David, and I hope to speak to you soon.

Swartz: Thank you.

Get Morningstar insights in your inbox