1 bright green flag for Nike

Nike (NYSE: NKE) is one of the most iconic sports brands in the world. The company rebounded strongly in 2021 after the pandemic hurt sales in 2020. Management is confident the momentum will continue.

Interestingly, Nike is making a significant strategy shift that could be a bright green flag for investors. Nike is focusing on direct-to-consumer sales, sometimes skipping wholesalers, which could boost gross profit margins in the long run.

Nike focuses on direct-to-consumer sales

Remember that Nike sells directly to customers through its website, app, and retail outlets. It also generates revenue by selling products to wholesalers, who then sell its products to customers around the world. Of course, Nike’s profit margins are greater when it sells directly to consumers rather than through wholesalers.

In fiscal 2020, management felt confident enough in Nike’s direct-to-consumer business to allocate a higher percentage of its inventory to this channel. As part of this transition, he informed several of his wholesale partners that he would no longer work with them. Additionally, he told others that they might receive less inventory from Nike than in the past.

NKE Gross Profit Margin Data by YCharts

During Nike’s fourth quarter conference call, management noted that since implementing this change in strategy, its gross profit margins were 260 basis points higher. This includes the 100 basis point headwind from high shipping costs since the start of the pandemic. This means the strategy is responsible for a 360 basis point increase in the company’s gross profit margin. To put that number into context, Nike’s gross profit margin averaged 44.6% over the last decade, so a 3.6% increase is a significant sum.

Of course, whenever you discuss profit margin growth, you want to check whether it comes at the expense of revenue growth. It’s not a remarkable achievement to raise prices and increase profit margins while experiencing declining sales in the process. This was not the case for Nike. After the 4.4% drop in sales in 2020, attributable to the pandemic, sales increased by 19.1% in 2021. The momentum continued in its recently ended fiscal year 2022, in which revenues increased by 5%.

What this could mean for Nike investors

Diluted NKE EPS chart (annual)

Diluted NKE EPS data (annual) by YCharts

Management is confident that its focus on direct-to-consumer sales could push its gross profit margin percentage up to 40%. If sales growth persists and Nike hits higher gross profit margin targets, that will translate to an overall increase in profits, a bright green flag for investors.

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Parkev Tatevosian has no position in the stocks mentioned. The Motley Fool holds positions and endorses Nike. The Motley Fool has a disclosure policy.

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