Nike's Q2 Report Strengthens The Bear Case

Morgan Stanley has maintained its Equal-Weight rating on Nike Inc NKE, saying the second-quarter report, especially weak futures, strengthens the bear case.

The market expected Nike's U.S. business to improve by the end of second quarter, but 4 percent drop in North America futures growth suggests otherwise. This implies Nike is either losing share or the athletic wear category is weakening or both.

“Overall sales will likely be better, but probably mostly due to clearing excess inventory via outlet stores, which is not the healthy type of growth the market is looking for,” analyst Jay Sole wrote in a note.

The analyst is also concerned with high inventory levels that points to slower than expected sales and limits upward EPS revision potential.

Sole also warned that Nike's gross margin will likely be pressured more than the Street expects for at least the next two quarters.

“The market will have to see new Nike products steal fashion momentum away from the competition before getting more excited. This is unlikely until spring at the earliest,” Sole continued.

Justification For Equal-Weight Rating

Sole remains on the sidelines on Nike shares for the following three reasons:

1. “Trough relative valuation implies much bad news is already priced in.”
2. “We think Nike has a 15c SG&A cushion which limits downside FY17 EPS risk.”
3. “The 3–5 year story is still compelling. We believe Nike's ‘Manufacturing Revolution’ holds significant potential and thus we are keeping our out-year assumptions mostly intact.”

Further, the analyst said the industry read-through of Nike’s results is mostly negative as Nike's high inventory level likely means heavy discounting will continue well into the first quarter.

At last check, shares of Nike were up 0.17 percent to $51.89. Sole has a price target of $56.