What China Market Offers Nike(NKE) to Fight Recession?

In the deep dive analysis of Nike (NKE) (read it here), I covered its growth potential in Asian countries. Later, I had one discussion about NKE on a stock forum, which prompted me to think deeper about the opportunities that China market presents to NKE. We'd like to pick companies managing to grow despite the worldwide recession. But given today's situation, it is reasonable to assume that the overall economic activities may slow down to such an extent that growth becomes unattainable for most of the companies. Nonetheless, we know that almost every company has some numbers from 'Wall Street' to beat, which, for some, is the key of the entire stock game. So the question is, does China market present a chance for Nike to beat its numbers? My answer: very likely.

1. Aggressive expansion may offset flat or declining revenue from existing stores. In the F2Q09 earning call, NKE management described China market as, 'China remains a premiere growth opportunity for the Nike brand. Revenue there is up 27% and futures are up 25%. Nothing has softened our enthusiasm for this market, or the Chinese consumers and their passion for sports. We’ve lightened our lead in brand awareness in China and now with more than 4,000 stores in tier-1 and tier-2 cities, we are well-positioned to compete and capitalize on the consumer connections we have built there.' (http://seekingalpha.com/article/111314-nike-f2q09-qtr-end-11-30-08-earnings-call-transcript?page=3) 4000 stores, that sounds a lot; and tier-1 and tier-2 cities, what does this mean? China cities are commonly segmented into different tiers, normally 4, based on the economic importance. However, there are no definitive standards for how the cities should be categorized. If you google it, you should be able to find two basic versions, one of them categories around 30 top China cities as tier 1 & 2, but obviously, for our case, Nike’s potential market in China won’t be limited to these 30 cities. A second version, a broader one, ‘A common approach is to put the four municipalities (Beijing, Shanghai, Tianjing, Chongqing), 27 provincial capitals, and a handful prosperous prefecture cities such as Shenzhen, Dalian and Ningbo into Tier 1, the more than 300 prefecture cities into Tier 2, the 1,200 city associated districts & county-level cities into Tier 3, and 1,600 counties into Tier 4.’ (http://www.bain.com/bainweb/publications/publications_detail.asp?id=26847&menu_url=publications_results.asp). Let’s not talk about tier 3 and 4, as I don’t think Nike would have the resources to tap into these cities in the next few years. And for tier 1 and 2, estimated around 450 million [note 1] population, we are having 4000 stores, so roughly, we are talking about 12 stores per city, with each one serving around 110,000 people. While in the US, 'We estimate that we sell to more than 25,000 retail accounts in the United States' (2008 10K), which translates to 12000 people per store. Sure the average household income in America is significantly higher than China, but here the comparison is based on a 450 million population from big cities, with more than one billion from tier 3 & 4 cities, as well rural areas filtered out. So here, I see unbeatable growth opportunities for Nike. Maybe across all regions, the economic downturn will cut into people’s spending, and you will see the revenues generated per store flat or declining, but Nike may compensate and turn things around by simply opening more stores in more cities. I won’t be surprised to see Nike continue the growth streak.

2. Nike’s core customer base is affected by the recession not as much as perceived. As I mentioned in another blog, Nike actually has a higher price tag on their products in China than in the US. Using footwear as the example, in the US market, normally the prices are between $50 and $140, and you can easily find sale items below $50, or if you live close to a factor store, the deals may be even cheaper. While in China, most of the shoes are above $100, when on sale, you may see a few items drop to around $60, and factory store? Never heard of. Keep in mind that the average personal income in China is still below $3000, so it is hard to imagine anybody spend 3% of yearly income on a pair of athletic shoes. However, it is just at this price level that NKE sees its double-digit growth year after year. This tells us that the core customers of NKE are not those from tier 3 & 4 cities and rural areas, but the groups from medium or large cities with higher disposable incomes. The immediate question to follow is that how much is this group of consumers affected by the recession? We know that a significant portion of China’s growth was fueled by the export-oriented industries, which simply depend on the economy of the US and the Europe. You see in China the unemployment rate shoot up as American and European economy contracts, but the rate is sort of skewed by the disproportionately high number in these export-oriented industries, as they are labor intensive, hiring a huge number of ‘blue collar’ workers from rural areas. They are the low-income groups in China, might be the very groups that make Nike shoes, but not the group that could afford the shoes. On the other hand, the unemployment rate in organizations that NKE’s customers work for, such as the government, the government controlled enterprises, or privately/collectively owned enterprises, is much lower than the number we see on papers. Another important factor to keep in mind. The social stability is always the top priority for the Chinese government since it has to manage such a gigantic population, therefore it takes firm measures to contain the unemployment rate at an acceptable level, for example, it makes the enterprises reduce employee’s salaries instead of laying them off if cutting cost becomes a have-to. This offers another protection layer of the purchasing power of NKE customers.

3. The money management pattern of Chinese customers makes them not as vulnerable as the customers in the US under the economic pressure. We just witnessed the burst of the Chinese stock market bubble. In the year 2007, it looked like investing in stocks became the single theme of people’s daily life for the entire nation, which pushed the market index almost 5 fold higher in 12 months and eventually reached an unsustainable level. Setting aside all the market manipulations, one interesting yet important fact you can gather from this is the vast savings the Chinese people have in their bank accounts. Actually this reflects a Chinese tradition in money management: no debt, saving for the future. This concept evolved as China society is becoming more open, but is still the mainstream. As a matter of fact, credit cards just started getting acknowledged and gaining some momentum in the past 2 –3 years in a few cities. I won’t elaborate on this topic, as this is more like an indirect and habitual factor. The key is: since the customers, as a group, have descent savings, little or none debt, the pressure from the economic slowdown is much less compared to their counterparts in the US, who normally are constantly haunted by the fear to sell the house and the car once the job is lost. As a result, they may not scale back their spending as steeply as imagined. This is not unique to Nike’s customer, but definitely a positive factor.

So here are the conclusions. First, there is no doubt that China market offers NKE the golden opportunity to thrive through the recession. Then the rest of the story is about NIKE's execution. Up to today, things I read about NKE are pretty positive. Second, everything I described here actually is not unique to NKE, all companies that operates in this 'sub-luxury' consumer products sector may take advantage of China market as well, for example, Apple. We will talk more about it in the next few blogs.

Note 1: not rock solid science, it is my estimation. The same source mentions among the 300 tier-2 cities, 120 of them have populations over one million, so it is 120 millions. For the rest 180 cities, I assigned an arbitrary number, 100 millions (maybe too conservative), based on my readings of China related materials. Then we have the big 4 cities, around 80 millions total, then the 30 other tier-1 cities, 150 millions.