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Analyzing Nike’s Expanding Profitability

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Analyzing Nike’s costs and margins in 3Q15

Nike’s (NKE) gross profit rose 10% year-over-year (or YoY) to $3.4 billion in 3Q15. The cost of goods sold, which includes the cost of materials, labor, and overhead used in production, was up by 4%. This was a slower pace of growth compared to sales, which rose 7% to $7.5 billion.

Nike’s higher pace of revenue increase resulted in improved profitability, and its gross margin rose from 44.5% in 2Q14 to 45.9% in 3Q15.

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Margin expansion

The expansion in Nike’s gross margin resulted from a shift to higher-priced products in the sales mix. Prices have been on the rise for both footwear and apparel, and the average selling prices for products were up by 6% in the quarter.

The expansion of margins would have been higher, but the West Coast port shutdown prevented products from reaching stores. This resulted in both lower sales growth and higher inventory levels in the quarter.

Costs deleverage

Nike’s margins were negatively impacted by higher costs of production and storage, as well as warehousing costs. The company’s selling, general, and administrative (or SG&A) expenses also expanded at a faster clip compared to revenue, rising 10% YoY to $2.4 billion. The expansion of its direct-to-consumer business also incurred higher operating costs.

Nike’s expenses also rose on the company’s digital platform, infrastructure, and marketing initiatives. Its demand creation expense stayed flat in the quarter at $0.7 billion, due to the differences in timing product launches. Despite the adverse currency environment, as detailed in Part 5, Nike’s hedging programs mitigated some of the forex impact on costs.

Profitability increases

Nike’s operating income also rose by 11.7% YoY to $1.0 billion. Its operating profit margin also expanded to 14.0% in 3Q15 from 13.4% in 3Q14. In comparison, peers Lululemon Athletica (LULU), Under Armour (UA), Skechers (SKX), and Columbia Sportswear (COLM) reported operating profit margins of 26.1%, 16.3%, 5.8%, and 12.1%, respectively, in their last reported quarterly results.

SKX and COLM together constitute 0.24% of the portfolio holdings of the iShares Russell 2000 ETF (IWM), which has 13.8% of its holdings invested in consumer discretionary stocks.

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