Author’s note: This is a shortened version of an article published on iREIT on Alpha on May 9, 2022.
I’ve written about adidas (OTCQX:ADDYY) (OTCQX:ADDDF) several times in various items at this point. It is understandable to me that some investors have doubts about the investment given the evolution of the company’s share price. However, I want to take this opportunity to tell you why this is not the case for me.
Why, in fact, do I see recent share price weakness as a solid opportunity to stock up on adidas for the long haul. And I want to remind readers that this is a long term kind of outfit. Everything else doesn’t make sense to the business.
Let’s revisit the second largest sportswear brand in the world.
adidas – Revisiting the Company
adidas hasn’t had it easy since the macro crashed and Ukraine really started to crumble. The company has been overly punished by the market, dropping double digits since I last wrote about the stock.
In some ways, these reactions are understandable, as recent macro changes have highlighted the continuing challenges of 2022E for adidas. These near-term challenges caused several European analysts, including some I work close to, to adjust their price targets for the company. Some of the trends will certainly impact EPS over the next 1-2 years, and it is fair to adjust our short-term expectations accordingly.
Still, my clear position is that significant advantages are now apparent at adidas.
Let’s go over the challenges here.
As mentioned in my first article on adidas, the company has faced a number of fundamental challenges.
The first and most important of these is the supply chain disruptions and the current environment in China, which keep on going weigh on corporate results, despite very solid gains in the non-Chinese market. The disruptions, partly due to COVID-19 as well as lockdowns, and now partly due to overall macroeconomic instability, continue to put pressure on the company’s share price. It is impossible to say or predict when this will reverse.
The Russian-Ukrainian conflict has seriously disrupted the global supply chain and the balance of demand for raw materials and energy. Energy-fueled inflation has led to a significant drop in consumer confidence in the Eurozone and the United States, with the rising cost of living potentially forcing consumers to shift their income distribution.
These things only justify a change in adidas’ valuation targets because it is realistic do this. However, this does not provide the company with the kind of headwind that won’t subside over time.
I don’t want to oversimplify things, but the real truth is that the only responsible difference from my last article is increased visibility of EPS pressure related partly to China and partly to supply chain caused by conflict and commodity pressures. How much we should expect for these is, like many things, a matter of opinion and calculation.
I’ll show you in the review segment how I think these impacts should be fairly considered, and why adidas is an even stronger buy than when I last talked about it.
However, I also believe that these pressures should do not overshadow the positive aspects of the business – which I believe they are now. Recall that we have full year and early 2022 results – and let’s see what they are.
adidas actually announced a rather positive outlook for the year, despite the lack of consensus in 4Q21. Notwithstanding the challenging environment, adidas believes it can deliver full-price sales increases, an easing of SCM and normalized trading in China will result in another year of double-digit EPS growth and good profitability from adidas.
We could be under pressure for about a year on stock prices – but once these signals reverse, the upward trajectory can be violent – as evidenced by historical stock trends.
Remember that the unimpacted geographic performance was absolutely strong across all markets, with growth of 17% NA, 47% LATAM and 24% EMEA. Even China and APAC were up on a VS-2020 basis, and only China and APAC were down on a VS-2019 basis.
The company announced the expected dividend of €3.3 for the year and announced a very encouraging set of prospects until the end of March/beginning of April 2022, with GM expected up to 52%, around 11% of OM and a net profit of almost 2 billion euros in a full year.
The company reported very encouraging margins thanks to lower inventories. COVID-19 has not only reduced overall inventory levels, but also its composition into a more attractive mix. The US market has always been oversupplied due to strong demand. The unusual business environment caused by the pandemic and supply chain challenges have changed this. Unwavering demand and relatively low inventories in the sporting goods market translate into a favorable pricing environment.
adidas is a market leader in sportswear pricing power. The improvement in margins in North America and Latin America is proof of this and could potentially weigh on the group’s unfavorable geographic sales mix in the future.
The headwinds of the business will remain for the rest of the year. This seems to go without saying at this point. However, adidas focus on what they can. Remember that there is absolutely nothing the company can do about the macro. But he can focus on his sales channels and try to drive growth.
The company’s activity should still experience double-digit growth in 2022 (80% at least). The company has a very strong backlog amid strong trends in NA, EMEA, LATAM and APAC, and also intends to increase product prices in 2H22.
The company’s current expectation for the end of the lockdown is around 3Q22, which means there is unlikely to be a sudden reversal in China here.
The very recent (May 6) adidas signings are a slight slowdown in sales due to ongoing SCM challenges, but strong sales growth in the Western market with constant currency sales up 13% in NA, 9 % in EMEA and 38% in LATAM.
“In the first quarter, consumer demand for our brand and products was strong in all Western markets. Our combined sales in North America, EMEA and Latin America grew at a double-digit rate. Supported by an exceptionally strong wholesale order book and a continued focus on growing our own DTC channels, we expect this positive development to continue for the remainder of the year. »
(Source: Kasper Rorsted, CEO of adidas)
adidas is, to put it simply, facing some trends that many “good” companies face. While revenues and sales are up sharply, margins and profitability are shrinking due to supply chain and material costs. Adidas will need to add targets to address this over the coming quarters. However, the company still posts a quarterly operating margin of more than 8% and an operating profit close to half a billion euros on a quarterly basis, with a net result of more than 300 million euros.
Despite these external factors, adidas only confirmed a day ago as of this writing its high and low outlook for 2022E.
I believe that the company is excessively punished. While I will hurt the business and moderate my price target for the business, I will do so conservatively and for the long term – as my holding target is long term 3-5 years or more.
adidas Rating Update
Regarding the degree of adjustment of the company’s estimates, analysts obviously differ somewhat. Some of my colleagues have adjusted the company’s 2022-2023 EPS estimates down by 20-35% from double digits to single digits. While I think 2022E should be impacted at least at €8.5-8.8/share, I don’t see the same impact in 2023E as I think markets will normalize here. Therefore, my downward adjustments are not as large as, say, AlphaValue. Equity analysts changed the DCF and NAV targets from €300+ to less than €280/share, giving a price target closer to €270 than €300.
S&P Global has also significantly changed its end-2021 targets, where the average was €322, to €277/share now. However, the number of analysts considering adidas a “BUY” or an “Outperformer” is now at 24/30 analysts, with only 1 analyst recommending a “SELL”. These are high conviction PTs and position changes are easily tracked.
You won’t find me discussing price drops for adidas in terms of PT. My previous price target, set in December 2021, was €300/share, which is lower than my fellow S&P Global and Equity analysts in Europe. As a result, my target reduction is also lower than my colleagues, as I prefer to start more conservatively, but also think they are too extreme in their assumptions for the 2H22 and 2023E impact.
I give the most weight to DCF in my analysis, followed by NAV, followed by peer multiples. The company has an advantage in each of these perspectives, and I find myself at an average price of around €280/share, which is around €20/share more than stock analysts who follow the company, such as AlphaValue, and a few euros higher than S&P Global.
The company is now trading at pandemic levels in terms of P/E multiples, around 21.7X on average.
The upside, as you can see, if the estimates materialize, is enormous. It’s what the adidas bulls, myself included, are counting on for the long haul. I invested over €40,000 in adidas. In the longer term, I estimate this will be well over €80,000, not including dividends. Representing a forward P/E close to 30X, the full potential 3-year RoR to 2024E is well over 100% here.
Even if you think adidas for some reason should trade at a 33% discount to NIKE, the upside to 2024E is still almost 70%.
For me, that’s really kind of a plus for a company like this – and I’m very happy to see this kind of award for a great company.
adidas has obviously underperformed the broader indices so far. It’s impossible to say exactly when that will change – but until it does, I’ll continue to stock up on a great company at a bargain price.
This is my review update for adidas. Some risks, yes. Earnings could be lower in the near term – but I believe in a significant normalization of longer-term valuations due to strong earnings and trends once these challenges subside.
This will result in significant market outperformance.