We’re taking Adidas above Nike on our Best Idea Long list. Today’s quarter was exceptional, and, for the most part, validated every part of our call for adding Adidas to our Best Ideas Long list on 4/3. The company put up EPS of €1.93 vs the Street at €1.58 and our €1.86, and took up the full year guide. The only wrinkle was China, which was down 16% vs last year, and was the only major region to not exceed 2019 levels. We’re confident that Adidas will see a sharp acceleration in its China business in 2H and 2022. As per guidance, people got spooked because there is a €500mm (7%) ‘hole’ in 3Q revenue expected due to the manufacturing delays from closed factories in South Vietnam. This is not just an Adidas issue, we’ve known about it for weeks, and it will impact Nike as well. But it was enough to take the stock down. If we have one knock on Adidas, it’s that the company is almost too transparent…management highlights nearly every top and bottom line headwind every quarter, which gets investors over-fixated on the wrong things. This is one area where Adidas can pull a page from Nike’s playbook. Nike never acknowledges any challenges – they spin the story, and one way or another, the company rallies and overcomes any and all obstacles. Though it needs to work on its messaging/spin-control, the reality is that Adidas is going to come in and beat the guidance it set forth on today’s call. In fact, we can’t recall a time when there has been more of a pad for this company to beat expectations in a very big way. Somehow management got the Street’s 4Q estimate DOWN by 20% to €0.65. We’re coming in at better than €2.00. For the first time in a VERY long time, we have greater upside in our Adidas model than we do for Nike. So… the company should handily beat the two upcoming quarters, jettison Reebok (good riddance) within a month, use the cash to buy back stock, then host its innovation day in Dec for the Street, all while changing the narrative such that people begin talking about TAIL EPS power of €20+. If those numbers are right, and Adidas sticks to the plan it outlined on its investor day (see comments below) then we’ll see Adidas start to narrow the valuation gap with Nike, which we assume narrows by 5% per year. That suggests that this name is more than a double over a TAIL duration with disproportionately little risk to the downside.
Best Idea Note from 4/3
We’re adding Adidas (ADS-DE €270, or ADDYY ADR $161) to our Best Idea Long list, and see 75% upside over 18-24 months. This is a first for us…we’ve ridden the Nike train for longer than I can remember – rightly so -- and Adidas has more often than not been a distant #2 as it relates to market share gains/losses and generating returns for shareholders over long periods of time. Adidas consistently tried to play Nike’s game, and it lost more often than not. At a minimum, it put up financials that were erratic, and definitely unworthy of the multiple that Nike has graduated into as it proved superior consistency in over-delivering on its operational and financial targets.
Well, we think that’s all about to change. Don’t get me wrong – Nike is executing better than ever, and expectations there are too low. We still like that name and think it will beat expectations over a TREND and TAIL duration. But this, for all intents and purposes, is a Global Duopoly, and we think that the #2 player – Adidas – will finally begin to consistently exhibit some Nike-esque financial characteristics while it takes a meaningfully different and complementary path in the marketplace and operationally to achieve those financial goals. As such, we think that Adidas will finally over-deliver on a consistent basis on its financial targets and will narrow the 25% valuation gap with Nike.
It’s been roughly a month since Adidas launched it’s ‘Own the Game’ strategy, mapping out the company’s goals – both operational and financial – through 2025. For the first time in two decades of covering Adidas, I think that its financial plan is not only achievable, but beatable. In fact, I think that it will hit its 2025 targets by 2023, and will beat 2021 by ~15-20%.
The problem with Adidas in the past is that it tried to replicate everything Nike did – competing in all sports and all categories, without particular focus in a ‘power alley’ of consumer segments, sports, or distribution channels. That’s why it always came up as a distant ‘silver medal winner’ in the race with Nike. But the company’s new plan is about as focused as I’ve ever seen any management team at Adidas. It’s leveraging its own assets, instead of trying to replicate someone else’s. Kasper Rorsted has been CEO of Adidas for 5-years after having been appointed in 2016, and the plan he laid out last month rivals Nike in focus, and resource allocation (both HR and financial capital).
- The biggest change is that the company is finally getting rid of Reebok. It’s about time. Literally no good came from this disastrous deal. Adidas bought Reebok in 2006 for $3.8bn. Quite literally, the two CEOs of the companies did the deal in the ultimate defensive move as they both were consistently unable to gain share from Nike in the US market. I worked at Nike at the time and recall doing high-fives around the water cooler and in the hallways when it was announced because the deal had disaster written all over it. It was orchestrated to take on Nike in the US, but the problem is that no two brands competed more directly in the US market than Adidas and Reebok. The Adidas and Reebok brands each had between 8-10% share of the market at that point in time, and within 3-years, the combined share was down 6%. It was cannibalistic and destructive. For the next decade, the old management team at Adidas German-engineered Reebok – which was a mistake. It cost management countless hours of focus, and the two brands battled against each other for market share on a continuous basis – ceding over 1,000bp of collective share to Nike North America. Press reports have Adidas expected to net close to $2.4bn in a sale of Reebok. That’s too high. It’ll be lucky to get $1.5bn. But Adidas will be happy to take the loss, get the cash and then focus on the core Adidas brand – which is a globally-defendable asset.
- Regional Focus. The next change is that instead of being focused equally on every region on the globe, it is focusing efforts on three primary regions – China, North America and Europe. It can literally hold its share in other markets such as South/Central America, Non-China Asia, and Emerging Markets and still deliver a consistent 10% top line growth rate (goal is 8-10% -- though I think the company will beat that).
- Sports Focus – 80/20 rule. As it relates to sports, AdiBok competed in every sport under the sun. But now the company’s focus will narrow from 20 categories to five primary categories that will account for 80% of total sales and 95% of growth over 5-years – Football/Soccer, Running, Training, Outdoor, Lifestyle. Notice that it’s no longer trying to compete with Nike in US basketball where NKE has 95% share in shoes over a $160 price point. It’s finally competing where it can win and not destroy its capital and see its image flail. Expect to see more rational behavior as it relates to athlete endorsements out of Adidas in achieving this plan – one of the many reasons we have ROIC hitting new peaks of 22% -- which would mark the first time in modern history Adidas will be over the 20% ROIC threshold.
- Introduction of Sportswear line. The lines have always blurred on the fringe of Sport and Fashion. I like that Adidas is launching a line specifically tailored to the make this gray area a crisp commercial opportunity – again, with heavy focus on DTC distribution. It sits between Adidas Performance (at similar price points), and the Premium-priced Adidas Originals. Launch in 2022. It should also help compete more aggressively with the Nike’s and Lululemon’s of the world with a more defined and differentiated women's product line.
- Partnerships. One area where Adidas excels vs Nike is in partnerships with the fashion community, that will be an increasing part of the equation – though with sales tied directly towards DTC. This includes Y-3, Stella McCartney, Ivy Park (Beyonce), Peloton, Yeezy. Expect the company to be more selective with distribution and price on these partnerships – but this one area where Adidas has experienced success where Nike largely has not.
- Channel Shift is Key. Change in channel is the most Nike-esque shift we’re seeing out of Adidas. By 2025, the brand plans to have 50% of its global sales as Direct to Consumer. We should note that it’s already at 40% (Nike is at 33%), with a 50/50 split between retail and digital. The goal is to add on another 10% of the mix in digital. That should be a slam dunk. It’s also about 1,500 bp accretive to gross margin based on our math. And with the combination of less discounting due to greater focus by category and geography, that adds up to about 100bp improvement in Gross Margin each year. Note that both brands will be at 50% DTC by 2025 – that a huge multiple lift for the group overall due to the greater margin profile, but more importantly, due to greater control of the brand.
Putting it all together…we come out with financials that are above the company’s stated goals for 2021 as well as its ‘ambitions’ for 2025. But we’re ok with that. That puts us well above consensus, as outlined in the table below. But more important than coming in ahead of the Street, in our opinion, is the consistency as to how the company delivers. Erratic results won’t close the valuation gap with Nike – consistency will, especially as both companies put up margin levels that are hitting new peak while distribution is 50%+ DTC as the brands take control of their own distribution and shift increasingly away from the old-school wholesale footwear model. A key part of our valuation framework is that ADDYY sits at a 25% discount to NKE today on EBITDA, and we assume that discount narrows by 500bp per year as Adidas finds its grove in the global duopoly and over-delivers on its' promises. If this was the old Adidas management team, there's no way I'd give it credit for executing -- but Rorsted's team definitely gets the nod from an execution standpoint. On top of our above-consensus EBITDA and EPS estimates, that suggests 40% upside in a year, 75% in 2-years and a three-bagger by year-5 of our model.
