The Hard Part of Nike's Turnaround Is Just Beginning

After several difficult years, Nike (NYSE: NKE) has finally stabilized.

Revenue declines have moderated. Inventory levels look healthier than they did a year ago. Management has stepped back from its aggressive direct-to-consumer push and rebuilt key wholesale relationships.

The slide appears to have stopped. But stopping the decline was the easier task. Rebuilding the earnings profile is far harder.

Image source: Getty Images.

The reset was unavoidable

Nike's challenges were structural, not cosmetic.

Fiscal year 2025 (ended May 31, 2025) revenue fell roughly 10% year over year, a rare contraction for a company that once delivered steady mid-single-digit growth. Gross margins compressed meaningfully (down 190 basis points to 42.7%) as promotions increased to clear excess inventory.

While the brand power remained strong, the operating model had weakened. In particular, Nike's earlier push into direct-to-consumer, while it made sense, did not deliver on the promised higher margins and deeper customer relationships. Worse, digital growth did not scale quickly enough to offset reduced wholesale exposure. Consequently, inventory forecasting faltered, leading to massive discounting to reduce inventories.

Meanwhile, competition intensified in performance categories, particularly running -- a segment that historically reinforced Nike's pricing power.

Put together, these factors led to revenue contraction, margin compression, and a change in investors' perception of Nike's future.

Stabilization is only phase one

To revive the business model, Nike has begun its turnaround centered on its new focus of "Win Now." While still early, recent quarters suggest that the worst of the revenue pressure may be behind the company.

For perspective, revenue increased 1% in the second quarter of fiscal 2026, led mainly by a recovery of Wholesale performance. Inventory also appeared better aligned with demand, down 3% due to lower units.

Those are essential steps. But they represent stabilization, not restoration.

At its peak, Nike operated with operating margins comfortably in the mid- to high teens. In the first half of fiscal 2026, operating margin fell to just 7.8%, significantly below historical levels.

Until operating leverage rebuilds, the turnaround work remains incomplete.

What would signal real progress

For Nike to move from stabilization to recovery, three things must occur.

First, gross margin must expand consistently, not just rebound for a single quarter. Structural improvement signals restored pricing power. Second, revenue growth must return without reliance on heavy promotions. Third, operating expense discipline must improve. Revenue growth without cost control will not restore earnings momentum.

If these elements align, even modest revenue growth can translate into meaningful earnings-per-share acceleration over the next several years.

What does it mean for investors?

Nike has already completed phase one of its reset: Stopping the deterioration.

Phase two -- restoring margin resilience and earnings compounding -- will determine whether the company regains its premium standing.

Investors are no longer debating whether Nike can survive. They are debating whether it can rebuild durable operating leverage.

That distinction will define the stock's long-term trajectory, so investors should track that closely in the coming quarters.

Lawrence Nga has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nike. The Motley Fool has a disclosure policy.