What Nike’s earnings report tells us about 3 consumer stocks in our portfolio

People walk past a store of the sporting goods retailer Nike Inc. at a shopping complex in Beijing, China March 25, 2021.

Florence Lo | Reuters

A warning from Nike (NKE) in its first-quarter earnings report has given us some serious insights into a handful of consumer stocks in the portfolio.

We call them “readthroughs”: valuable investment clues we find by sifting through financials and comments from other companies, including ones not owned by Jim Cramer’s Charitable Trust, the portfolio we use for the Club. While it’s a never-ending process, quarterly results and earnings calls are gold mines for these readthroughs.

TJX Companies

Shoppers come and go the TJ Maxx store at the Mall at Prince George’s on August 17, 2022 in Hyattsville, Maryland.

Chip Somodevilla | Getty Images

The biggest takeaway in Nike’s quarter — and not just for us, but for Wall Street overall — is that the apparel giant has a major inventory problem in North America. Its shelves in the region swelled 65% in the first quarter compared with the same three-month window last year.

  • The cause is understandable: pandemic-induced supply chain complications, such as late deliveries over the past two seasons and early holiday orders. Nike is not an outlier in experiencing this.
  • The effect is good news for TJX Companies: Nike is taking “decisive motion to clear extra stock,” according to Nike CFO Matthew Friend.

Retail’s inventory glut is a key reason why we started a position in TJX, the parent company of Marshalls and TJ Maxx, in late August. Apparel makers and sellers don’t want to hold onto excess goods, especially when more seasonally relevant clothes are on their way. They want to get rid of it, even if it means taking the kind of short-term hit to profits that Nike said it’s likely to experience.

Off-price retailers such as TJX are the beneficiary of these industry dynamics. Here is the company in its own words, in its 2021 annual report:

“With many retailers continuing to close stores and with congestion in the supply chain, we offer vendors an attractive solution for clearing inventory,” TJX wrote, including later that it’s “in an incredible place to reap the benefits of the plentiful off-price shopping for alternatives in {the marketplace}.”

Nike is likely utilizing multiple approaches to get rid of its excess inventory, including markdowns in their own stores. However, Nike’s quarter makes it clear the “plentiful off-price shopping for alternatives” that TJX Companies has seen have not disappeared yet.

TJX shares were up more than 1.5% Friday, while Nike shares slumped more than 10%.

Starbucks & Apple

Alex Tai/SOPA Images | LightRocket | Getty Images

Nike’s negative China sales serve as a reminder about the current complexities of doing business in the world’s second-largest economy.

  • Nike’s sales in China were $1.66 billion in the first quarter. While that met Wall Street’s tempered expectations, it still represented a 16% year-over-year decline.
  • Nike’s earnings before interest and taxes (EBIT) in China also fell compared with a year earlier, down 23% to $541 million.

We had not forgotten about Beijing’s attempts to enforce its so-called “zero Covid coverage” and the economic problems associated with rolling lockdowns in major cities. Nevertheless, Nike’s results are worth considering in the context of Club holdings Apple (AAPL) and Starbucks (SBUX), two other consumer-focused companies that count on China for growth.

We recognize the types of products the three companies sell vary greatly. Still, we have to remember that just because lockdowns have been lifted, we’re not out of the woods with business disruptions showing up in quarterly results. Not only are the results backward-looking — in Nike’s case, they cover the three months ended Aug. 31 — but it will take time for things to normalize. Fortunately, our extended investment horizon allows us to be patient.

On Nike’s earnings call Thursday night, CEO John Donahoe compared China to inflation in that “we won’t fully predict it.”

But structurally, we see some very encouraging signs with consumers,” Donahoe mentioned, including that Nike’s head of China operations, Angela Dong, is “very clear that they’re seeing Chinese consumers are emerging from these lockdowns with a real hunger for innovation, quality, and energized storytelling.”

Donahoe’s sentiment is just like what we heard from Starbucks earlier this month through the firm’s investor day. China is a large a part of Starbucks’ long-term imaginative and prescient — doubtlessly overtaking the U.S. as its greatest market by 2025 — nevertheless it’s not easy crusing simply but.

“With a partial lifting of Covid restrictions in different cities, I am very pleased to report that our recovery in China is well underway,” mentioned Belinda Wong, chairwoman of Starbucks China. “However, given ongoing restrictions under China’s dynamic zero-Covid policy and the unpredictability of the future outbreaks, we remain vigilant and our recovery path will continue to be nonlinear.”

For Apple, its China income declined 1% in the quarter ended June 25, with management saying the lockdowns took a chunk out of demand. The launch of the iPhone 14 in the center of this month might catalyze gross sales. Demand in China for high-end iPhone 14s seems “strong,” UBS analysts said in a note Thursday, with wait times for Pro models longer than they were in 2021. “However, considerably anticipated, the least costly iPhone 14 is available in China,” the agency mentioned, which means decrease demand.

Bottom line

The backside line is that for firms like Nike, Starbucks and Apple, it is all about the reopening story in China. Investors perceive its uneven, however additional rationalization of pandemic insurance policies might be excellent news for these firms. We noticed it with Club holding Wynn Resorts (WYNN) because the gaming hub of Macao took steps towards welcoming vacationers from mainland China once more. Shares of Wynn, which has two properties in Macao, soared Monday in response to that information.

We’re not essentially saying there is a comparable binary-type occasion that might spark main one-day strikes in SBUX or AAPL. However, traders need extra readability across the working atmosphere in China. As they acquire confidence that Beijing is easing off “zero Covid” in an actual means, we count on it to work its means into the inventory costs of Starbucks, Apple and the like.

(Jim Cramer’s Charitable Trust is lengthy TJX, COST and SBUX. See right here for a full record of the stocks.)

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