Morgan Stanley Says Buys The Nike Dip

Nike Inc NKE sold off Tuesday evening after posting first-quarter top- and bottom-line beats. Some experts are profiting on the pullback.

The Rating

Morgan Stanley analysts Lauren Cassel and Kimberly Greenberger maintained an Overweight rating on Nike and raised their price target from $88 to $103.

The Thesis

Digital sales accelerated in North America even as store comps marked higher traffic and improved conversion. At the same time, China sales grew 20 percent on 40-percent digital growth.

“Sportswear, running, basketball and Jordan all delivered impressive growth during the quarter and NKE is seeing no signs of a China slowdown with continued business momentum and demand for the brand,” Cassel and Greenberger wrote in a note.

The analysts acknowledged “unprecedented demand” for Nike’s premium footwear through the SNKRS app and expect continued expansion with upcoming app launches in Mexico, Brazil and Southeast Asia. Healthy inventories across all geographic markets positions the firm for strong second-quarter gross margins.

Nike’s flow-through rate, which increased from 9 percent to 26 percent quarter-over-quarter, yields similarly positive expectations.

“This highlights the margin benefit and future earnings power of NKE's direct to consumer transformation, in our view, and is a positive outlier in the sea of profitless growth we've observed this earnings season,” the analysts wrote.

Driven by gross margin beats and cuts to selling, general and administrative expenses (SG&A), Nike expanded its earnings-before-interest-and-tax margin by 120 basis points. Notably, Morgan Stanley considers the metric “in early innings.”

The analysts anticipate first-half pressure from inflation in rubber and other input costs, but the headwind is expected to clear in the back half to compound a forex tailwind. Altogether, the factors should drive year-over-year gross-margin growth.

Price Action

At time of publication, shares were set to open down 2.6 percent at a rate of $82.62.

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