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Nike’s Gross Margin Expected to Contract Further in Fiscal 2Q18

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Nike’s EPS expected to contract in 2Q18

As we’ve already seen in this series, apparel giant Nike (NKE) will report its fiscal second-quarter financial results on December 21, 2017. Its EPS (earnings per share) is expected to fall 18% YoY (year-over-year) to $0.41, according to Wall Street estimates. That would be the second quarterly fall in Nike’s earnings. Its EPS contracted 22% during fiscal 1Q18.

While the company’s earnings came under pressure in fiscal 1Q18, Nike nevertheless outperformed Wall Street projections. In fact, Nike hasn’t missed Wall Street expectations for 21 consecutive quarters.

Recent gross margin contraction

One of the key reasons for Nike’s falling earnings is its deteriorating gross margin, which has contracted over the last six quarters. Its fiscal 1Q18 gross margin fell 180 basis points to 43.7% of sales, primarily driven by currency headwinds and a challenging retail environment in the United States.

Nike derives around 55% of its total sales from international markets. As a result, the company is exposed to currency headwinds more than any of its competitors. However, higher international exposure also lowers the company’s effective tax rate. For instance, Nike had an effective tax rate of 13.2% during fiscal 2017. In comparison, Under Armour (UAA), which derives its sales mostly from the United States, had an effective tax rate of 33.8% in the same period.

How Nike is placed next to its competitors on profitability

A continuous decline in the gross profit rate over the last several quarters has hit Nike’s profitability. The company has a lower gross margin than most of its peers. Its trailing 12-month gross margin of 44.1% is lower than the margins for Adidas (ADDYY) (49.6%), Under Armour (UAA) (45.4%), Sketchers (SKX) (46.5%), and Lululemon Athletica (LULU) (51.7%).

Looking forward

Nike’s management has projected another decline of 50 to 100 basis points in reported gross margins for fiscal 2018. A challenging US retail environment and foreign exchange headwinds will probably once again be responsible for the fall.

For fiscal 2Q18, Nike’s gross profit rate is likely to contract at the same rate it did in the first quarter.

ETF investors seeking to add exposure to NKE can consider the SPDR Dow Jones Industrial Average ETF (DIA), which invests 1.8% of its portfolio in NKE.

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