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All about adidas (OTCMKTS:ADDDF)

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The demand for running shoes has been on an upward trend for the past few years due to the growing popularity of outdoor activities, according to Transparency Market Research.

This is good news for adidas (OTCQX:ADDYY), which is now the second most valuable clothing brand in the world, according to Kantar. Athleisure brands in general have been on the rise, including Nike (NKE), Lululemon (LULU) and Puma (OTCPK: PMMAF).

The German group sells a range of athletic footwear, apparel and equipment through more than 2,100 adidas-owned stores, 15,000 franchises and around 150,000 wholesale deals globally. There is also an online channel which has grown rapidly in recent years. adidas has also diversified geographically. The Americas and Europe together account for just over half of total sales, and Asia-Pacific now accounts for a third of sales.

Buy the dip

adidas’ share price has fallen about 35% this year, thanks to soaring inflation and lockdowns in China, which have put pressure on the consumer discretionary sector. Investors have differentiated athleisure brands, however, and adidas has fallen behind its biggest rival Nike in 2022, which owns 25% of the market-leading fitness and fashion footwear category. Second place adidas has 15% market share. Normally, this size difference translates into only a small valuation gap between the two groups. This year, that valuation gap has widened significantly, with Nike shares currently trading at 24x forward earnings, while adidas only has a multiple of the forward price on the PE of earnings. around 16, which is a seven-year low for adidas.

I think this valuation difference is unbalanced because adidas has a leading brand and a large global footprint and has been growing its annual profits faster than Nike for much of the last decade. adidas is valued even below its smaller rival Puma, which is on a forward PE ratio of 22x, despite only having a third tier of adidas sales.

Nike and adidas, the two biggest names in the sportswear market, have a lot in common. They charge high prices and have huge budgets. In fact, only Nike and adidas have the financial muscle and global appeal to dominate advertising and sponsorship. Smaller rivals like Under Armor (UAA) and Puma simply don’t have the power to sign deals with top athletes and sports teams. adidas sponsorships for big teams and big stars accounted for around 50% of its €2.5 billion in total marketing spend in 2021.

All the time?

This expense, which is intangible, helps adidas for all economic environments. Strong brand power really helps, historically, to retain both customers and pricing power, relative to competitors, during downturns. The brand defends pricing power. adidas’ pricing power is evident in its 50% average gross margin over 10 years. This is even higher than that of Nike. It’s also thanks to its higher mix of higher-margin sportswear and equipment sales. adidas, in my opinion, is one of the world’s best non-defensive stagflation investments.

adidas can increase its gross margin by a few percentage points from the estimated 52% in 2022, thanks to its “Own the Game” strategy. This is an increased focus on direct-to-consumer sales, which adidas launched in 2021. About 60% of adidas’ revenue comes from multi-brand retailers, and moving away from that allows adidas to capture the entire profits from a pair of sneakers. .

adidas is looking to have Direct-To-Consumer account for more than half of sales by 2025, and also plans to double its online sales to 9 billion euros during this period. This push has already begun, with growth in North America reaching over 20% in the first quarter of 2022. adidas’ focus on e-commerce is also on track, with sales nearly doubling over the past three years to reach almost 4 billion euros in 2021.

The adidas Q1 2022 results are available here.

Risks

High material inflation being passed on to consumers could reduce demand, all else being equal, but as mentioned, I think the adidas brand is mitigating that. A poor performance by adidas-sponsored teams and players in this year’s FIFA World Cup could lead to football spending being shifted to Nike or Puma, but this is a short-term issue.

Asian Hiccups

One of the reasons adidas’ share price has fallen is that it has become more dependent on China. The shutdowns in China have impacted sales, with revenue falling 16% in Asia-Pacific in the first quarter of this year. The shutdowns also prevented expected growth in Chinese markets from fading. China has been the fastest growing athleisure market in the world, so this has been a blow.

However, adidas management expects to offset the slowdown in China with “strong double-digit” growth in the rest of the business, which accounts for 80% of its sales. First-quarter constant currency sales growth of 12.8% and 9.1% in North America and the Europe, Middle East and Africa regions, respectively, indicates strong performance in key markets. Chinese growth has only been postponed – there’s nothing fundamentally wrong with adidas in China – so this sets up a nice period of future growth all down the line.

Returns to shareholders

Another reason to be optimistic about adidas is its improving position on shareholder returns. Last year, adidas took a big dip in Reebok, which it sold for 2.1 billion euros to Authentic Brands Group after paying 3.1 billion euros for it in 2006. management is now more cautious about spending, and the sale of Reebok has allowed adidas to pay down 600 million euros in debt in 2021. The group has doubled its dividend payout since 2015 with incremental increases, and it now has a dividend yield of 2.4%. I expect adidas to pay around €3.7 billion in dividends over the next five years, out of the €12.5 billion it is expected to generate in free cash flow over that period, and the management has committed to buy back shares, which I think would be an additional 7 euros. billion in returns to shareholders.

Summary

China is a short-term concern, but this issue is already taken care of. As investors, we must look to the future. The growing trend in the athleisure market seems unlikely to reverse, and adidas has a leading position and a strong brand. Its good cash generation and new focus on shareholder returns means good upside potential.