Nike: weak sneaker, weaker brand?

Tue 26 Feb 2019

Last week NBA star Zion Williamson’s sneaker tore into pieces early on in his game vs UNC and he subsequently left the court with a knee injury. Zion is widely regarded to be one of the most promising young stars (He is just 18 and is projected to be the first overall pick in the NBA 2019 draft). The sneaker he was wearing was the Nike PG2.5.

Former President of the United States Barack Obama was present for the game and footage of him pointing to the ripped sneaker went viral on social media platforms YouTube and Twitter. To many this may seem like nothing more than a simple product failure, and not much more to read into, sometimes sneakers break, right? Maybe the stitching was flawed from the beginning, maybe the shoe shouldn’t have passed through quality control. In any case, the sneaker ripping into two for thousands to see live led to a blow to Nike’s reputation. You can bet Nike’s marketing and sales team were not happy as their product failed as the whole world checked in to see. In the digital social media age, brands can fall just as quickly as they can grow. Warren Buffett said, “It takes 20 years to build a reputation and five minutes to ruin it” Nike’s reputation suffered a major hit in under 5 seconds on that Wednesday evening.

Nike’s stock fell 1% on the news. For top fashion/sportswear labels like Nike (or Adidas), one of their biggest assets is their pricing power that comes about through their brand name. Nike is synonymous with success, sporting dominance, and prestige. One need only to look at the athletes they sponsor: Cristiano Ronaldo, 5 time Ballon d’Or winner and arguably the best football player of our time. Lebron James, winner of 3 Finals MVP awards. Nike has always pushed its brand onto the backs (and feet) of the elite. Such a public display of their product failing to deliver painted Nike in the exact manner their marketing team surely strives to avoid.

Many renowned equity fund managers operate on the premise that in the long run, all one need to do to outperform the market is buy quality companies. This is the style that underpins managers like Warren Buffett, Nick Train and Terry Smith who all have a clear quality factor bias to their portfolios. These managers seek out companies that generate returns on invested capital greater than cost of capital, companies that can sustain high margins, companies that have pricing power and innovative products. And indeed, these managers seek out companies with strong brands that enable premium prices to be charged. When a company’s brand is ‘re-rated’ by the market, the entire investment case changes.

On that night the investment case for Nike, which is contingent on its status as a high-quality brand, was called into question. Businesses that generate a lot of value from their brand are susceptible to sudden changes in consumer sentiment and tastes and it will be a challenge for Nike to cement themselves as quality sneaker providers in the eyes of NBA fans for some time. The severity of the backlash will likely be dependent on how quickly Zion bounces back from his injury. However, often businesses can climb back from temporary brand hits and continue as market leaders. Unless the event was catastrophic, like when Gerald Ratner described his eponymous jewellery store’s products as “total crap” forcing the company to close hundreds of stores in Britain and the US, strong businesses can often prevail for the long term and it is unlikely Nike will lose its core fan base, and dominant market share, because of this alone.

As investment managers, we prefer equity funds with a slight quality bias (companies with high ROIC, high margins, high interest coverage) and we have sought out managers in the space able to identify these businesses. We appreciate that these funds often come with a higher valuation price tag and hence we also have exposure to value equity funds to achieve some valuation-factor diversification.