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Nike is dealing with 'unprecedented macro headwinds,' analyst says

John Kernan, Cowen Managing Director for Retail & Consumer Brands, joins Yahoo Finance Live to discuss retail trends and the outlook for brands like Nike, Gap, and Yeezy.

Video Transcript

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SEANA SMITH: All right, Kanye West is walking away from corporate America, telling Bloomberg that it's time for him to, quote, "go it alone" after his current contracts expire. Now the rapper is tied up with Adidas through 2026 and with Gap through 2030.

Joining us now for more on this, we want to bring in John Kernan. He is Cowan Managing Director of Consumer Retail and Consumer Brands. John, it's great to see you. So Adidas and Gap really both betting huge on Kanye. Of course, there's been lots of drama here between Kanye West and both brands. You cover Adidas. What does this mean for the brand?

JOHN KERNAN: Well, we think that the Yeezy brand for Adidas generates over $1 billion in revenue at least. And they pay Kanye quite a big royalty for his business. I think, you know, when you look at the structure of the contract, it runs through 2026. Adidas is also looking for a new CEO in 2023. So a lot of uncertainty as it relates to that company and brand right now.

You're seeing the stock at a multi-year low. When you think about what Yeezy means to the business, it's, like we said, it's over $1 billion in sales. It's probably over $100 billion in EBITs, a big portion of their business. They provide distribution and fulfillment and production.

So they're not designing the product. Kanye designs the product. But Adidas is really behind the distribution the production and fulfillment of that product. So hard to see how he's going to go it alone in a very quick manner. But it certainly represents a risk for him to not be in agreement with the Adidas corporate structure.

- Yeah, any guess how he might go it alone without that massive infrastructure of a company like Adidas?

JOHN KERNAN: Well, he could try to find a new partner. He's certainly in contract through 2026. So I don't think he's going anywhere anytime soon. But, again, it's a highly fluid situation. There's a lot of uncertainty about the long-term relationship. And, unfortunately, it's a pretty big portion of the overall Adidas financial model.

SEANA SMITH: It could be a huge headwind here for Adidas going forward. John, I know you've been doing some back-to-school checks, looking at the numbers just in terms of demand, some of the consumer trends. What are you seeing just in terms of what people are willing to spend on retail and where they're spending?

JOHN KERNAN: Yeah, sure, it's a bifurcated consumer environment out there for sure. We've seen strength at the high income consumer. We've seen a lot of pressure and trade down at the low income consumer. Within the athletic footwear and apparel space right now, Lululemon is really leading with their product cycle, enabled them to report revenue up 29% year over year in the most recent quarter, raised their guidance pretty significantly. There's not a lot of other companies in the space in my sector that are poised to raise guidance.

So Lululemon stands out, great product cycle in men's and women's. Others we've seen become much more promotional. And it's really due to the fact that the lower and middle income consumer is under a lot of inflationary pressure.

- How are companies like Nike and Adidas impacted by this environment?

JOHN KERNAN: Well, inventory levels in North America are very, very high. Nike's overall inventory dollars in North America were up 44% in its most recent quarter. They're going to report again in two weeks on September 29. I think inventory levels will remain high. We've seen that in the channel play itself out in very heavy apparel promotions throughout the sector. And whether it's Nike, Adidas, Under Armour, everyone's been a bit more promotional recently.

SEANA SMITH: John, you recently lowered your price target on Nike to $124 from $127, so not a huge move to the downside, but still lower here heading into earnings. Why are you, I guess, maybe not as bullish-- I don't even know if you can technically say that though-- as you once were-- because you still have that outperform rating.

JOHN KERNAN: Yeah, certainly the valuation has contracted quite a bit on Nike from the highs it was at last summer. Earnings estimates have been under pressure most recently from FX. That was really the justification of our lowering of our sales and EPS estimates into first quarter earnings that they're going to report on September 29. Look, the long-term Nike story, the long-term margin expansion, the shift to DTC, the shift to e-commerce creates a tremendous amount of earnings growth long term.

But in the near term, they're dealing with unprecedented macro headwinds, inventory levels, FX movements, European consumer that's now under incredible pressure. So I think when you look at what they already issued guidance for the full year, I don't think they're going to be apt to change that much. They certainly have to take up their headwind guidance.

So that probably puts a little bit of pressure on consensus estimates. I think they'll probably reiterate their reported full year sales guidance and EPS guidance for the year. But, ultimately, they do have to rain expectations in for the hit they're going to take from FX.

- John, you mentioned the European consumer. Looks like they are teetering on the edge of recession. Who has the most exposure to Europe and how will it impact them?

JOHN KERNAN: Yeah, sure, within my coverage list, Nike, Adidas, and Puma maintain the most exposure. Puma and Adidas both being European-based, have over a third of their business in Europe. Nike's a high 20% plus rate. Look, the consumer is under pressure there.

The cost of doing business is also going to go up there significantly, the cost of electricity and energy, stores, DCs, office buildings are all going to cost a lot more to operate. So everyone's under a lot of pressure in Europe. Everyone's expecting a recession. Certainly some of the valuation contraction we've seen over the last six to nine months in this sector is discounting some of this. But it's a very difficult modeling, financial modeling environment. And the earnings we're modeling into next year, it's pretty tricky.