Did Nike's Turnaround Just Hit a Wall? Here's What Investors Need To Know

Three months ago, Nike (NYSE: NKE) CEO Elliott Hill told investors that the company was in the "middle innings of our comeback."

The implication was that investors would see further progress in the fiscal third quarter, which the company reported Tuesday after hours. However, the market was underwhelmed with the results and its forecast, and the stock tumbled 9% after hours on the news, hovering around an eight-year low.

Revenue was flat at $11.28 billion, or down 3% in constant currency, which was just ahead of the average estimate at $11.23 billion. Gross margin fell 130 basis points to 40.2%, primarily due to tariffs in North America, and selling, general, and administrative expense rose 2% to $3.98 billion. That was enough to lead to a 23% decline in operating income to $635 million.

Due in part to a higher tax rate, earnings per share fell 35% to $0.35, which beat the consensus at $0.28.

While the results did top muted expectations, the sell-off was understandable as Nike's results worsened from the second to third quarters in most key categories, including revenue growth, gross margin, and earnings per share, as well as growth in key categories like wholesale revenue, which has been one of the company's sources of growth recently.

What's happening with the turnaround

As the trends above suggest, Nike's turnaround is moving more slowly than investors had hoped. Management said it is still working to clear excess inventory in classic styles so it can return the company's focus to innovation and performance gear.

Hill said that strategy led to a five-point headwind on revenue in the quarter, and the company will have reduced more than $4 billion in revenue from classic footwear franchises from their peak.

Management's guidance indicated that it expected the sequential trend in the third quarter to continue into the fourth quarter, forecasting a revenue decline of 2%-4% with growth in North America and continued declines in China and Converse. It didn't give bottom-line guidance, but the metrics it provided implied that margins would be down again. It also said it expected gross margin to return to growth in the second quarter of fiscal 2027, meaning investors shouldn't expect bottom-line growth for three more quarters, which was a disappointment.

However, there were some promising signs in the quarter. Running continues to be a bright spot for the company with revenue from the category up more than 20% in the quarter, and North American footwear, the focus of most of its turnaround efforts, is delivering solid revenue growth, up 6% in the quarter, though profits are falling in that key market due to tariffs and the company's markdown to cut back on classic styles. Though it continues to struggle in China with a 7% revenue decline, it did drive operating profit up 11% due to reduced promotions, inventory controls, and an improved sales mix.

What it means for investors

Nike stock is now down roughly 75% from its peak during the pandemic-era boom, and the stock has steadily declined since then.

Management is optimistic that the success it's had in running will translate into other sports, including soccer next, helped by the World Cup this summer, but it's understandable that the stock continues to fall. Investors only have so much patience for declining revenue and profits, and at a certain point, start questioning whether Nike is in permanent decline, losing market share to upstart brands like On Holdings and Deckers' Hoka.

Still, Hill has been at the helm for only a year-and-a-half, and his turnaround deserves a few more quarters to succeed. Additionally, Nike's results have been impacted by one-time headwinds like tariffs. Keep an eye on the Q2 2027 target for a return to gross margin growth. If Nike misses that, it may be time to give up on the turnaround.

Jeremy Bowman has positions in Nike. The Motley Fool has positions in and recommends Deckers Outdoor, Nike, and On Holding. The Motley Fool has a disclosure policy.