Adidas has become a major growth story in recent years and thus been scoring very highly in our growth-focused Markt Screener runs. In addition to projected multi-year double digit growth ahead, there are a couple of catalysts and factors that could yield a stock price of 200 euros in the not too distant future.
Sporting one of the best known brands in the world, Adidas runs a multi-brand strategy comprising the conventional brands Adidas and Reebok as well as some newer ones, such as Adidas Neo, NMD or XBYO. The company employs more than 60,000 people in over 160 countries who produce and sell more than 840 million product units every year. Global sales stood at 19 billion in 2016 distributed geographically as follows:
Today, the company competes neck-and-neck with Nike, the long-term market leader. This is a remarkable achievement after having struggled during the first decade of the 21st century due to lack of innovation and strategy as well as unfortunate acquisitions, such as the loss-making Reebok and golf equipment manufacturer TaylorMade (sold off last month).
Mostly, however, the turnaround can be contributed to the strategic shift to becoming a life-style brand, rather than making only apparel for sports (The fact that the popularity of soccer where Adidas has historically been strongest does not cease to grow has clearly helped as well). Nowadays, Adidas has partnerships in place with some of most notorious celebrities on the planet, such as Kanye West, West, Stella McCartney or Selena Gomez. Recently, sales in the Adidas brand Stan Smith have been surging.
In the sporting world aside from the success of football/soccer Adidas has successfully been poaching Nikes traditional stronghold in basketball or even baseball. Sales growth of 24% in 2016 in the North America region are evidence of this. This rapid growth was surpassed only by China where sales grew 28% yoy. This fact suggests massive growth potential as the planets largest country by population accounted for only 16% of Adidas sales in 2016.
Against this backdrop, the optimism in Adidas growth outlook is unsurprising. In March, Adidas lifted its outlook for profit growth to 20 22% per annum on average through 2020, compared with a previous growth projection of about 15 percent, driven particularly by continued consumer demand for sport-inspired streetwear.
Although Adidas has been exceeding Nikes revenue growth in recent years, it continues to trade at a significantly lower valuation of market cap/sales (1.64x vs. 2.58x for 2017). This is in large part due to an inferior degree of profitability as evidenced by a ROE of 18% vs. 32% for 2017. In light of this, investors and analysts have been demanding that Adidas divest the Reebok business (and prior to the sale the golf business) which it has unable to make consistently profitably in over 10 years of ownership. Though it may require a write-down upon the divestment, a sale of Reebok would boost Adidas margins and level of profitability considerably.
The following sums up our investment case for Adidas
- Buoyant market fundamentals
- CEO with a strong track record of value creation
- Sale of golfing unit may be an indication of a sale of Reebok potentially leading to higher margins and thus a higher valuation
- Together with Nike, Adidas is essentially part of a duopoly (two very dominant industry players who face very limited competitive challenges). Out of the remaining known market players, Reebok belongs to Adidas whereas Under Armour and Puma are comparatively small with only between 25% and 20% of revenue, respectively.
- Over several quarters, Adidas has consistently been beating analysts expectations (see chart below)
Risk and Weaknesses
Whilst the fundamental market growth Adidas benefits from appears secular, the company is of course subject to the risk of a global slowdown. However, none of the major institutions issuing forecasts on global growth are predicting this to occur over the short to medium term. Rather, global economic growth has been revised upwards in the past few months. Another potential risk stems from a competitive challenge by a new market entrant. This risk appears small as the only serious candidate on the horizon Under Armour, though growing rapidly, has been struggling with decreasing profitability.
Now that the Taylormade golf business has been sold, it can be expected that investors will increasingly urge Adidas to also divest the loss-making Reebok business and instead focus on its own brand and sub-brands as well as on the life style segment. Even though Adidas CEO Kaspar Rorsted recently reiterated the companys commitment to Reebok, this will not last indefinitely. Mr. Rorstedt is known for his rational focus on profitability, which he proved consistently at Henkel, where Mr. Rorstedt was a highly regarded CEO for eight years from 2008 to 2016.
If the growth rates are kept up and if improvements to Adidas profitability continue to be made, notably by an eventual sale of Reebok, there is no reason that Adidas discount to Nike in terms of market cap to sales of 36% should persist. Prior to catching up to Nikes valuation, however, we believe that shares in Adidas should get to 200 before closing the valuation gap which would occur at a share price of 267 (57% upside).
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Manufactures sports shoes and related productsadidas AG engages in design, distribution and marketing of athletic and sporting lifestyle products.It operates through the following segments: Western Europe, North America, Greater China, Russia or CIS, Latin America, Japan, Middle East, South Korea,...