FGM - adidas AG: Sales Growth Encouraging But Company Faces Headwinds

• adidas AG has seen strong sales growth across Western markets.
• However, this has been accompanied by a significant rise in operating overhead expenses driven by inflation.
• Investors are likely to pay more attention to earnings and cash flow performance going forward.

Investment Thesis: While adidas AG has shown encouraging sales growth, lack of growth in earnings and cash flow might be of greater concern to investors going forward.

In a previous article last month, I made the argument that adidas AG ( ADDDF , ADDYY ) could see upside going forward on the basis of strong performance across Western markets, in addition to an attractive P/E ratio.

In the past month, we have seen the stock trade largely in a stationary manner:

The purpose of this article is to assess whether the growth drivers I cited in my last article can still propel the stock upwards - taking recent quarterly performance into account. Please note that all figures sourced from relevant financial statements are given in euros.

Performance

adidas AG continued to show strong performance across Western markets in Q2 2022 , with overall growth of 14% across markets that represent over 85% of the company's overall business.

In terms of net sales, North America showed particularly strong growth of over 20% on a currency-adjusted basis:

On the basis of growth across EMEA and North America - adidas AG was able to compensate for the drop in growth that we saw across Greater China - in significant part due to COVID-19 lockdowns imposed earlier in the year.

From a balance sheet standpoint, we see that the quick ratio (as measured by cash plus accounts receivable all over total current liabilities) has decreased quite significantly:

Source: Figures sourced from adidas AG Q2 2022 Earnings Release. Quick ratio calculated by author.

While this is expected as bolstering revenue will invariably mean increasing expenses to fund such growth - a declining quick ratio does mean that adidas AG has less immediate cash available to meet its current liabilities.

Moreover, while sales growth itself continued to remain robust at 10.2% overall for Q2 2022 as compared to Q2 2021 - diluted earnings per share from continuing operations was down slightly from €1.93 to €1.88.

When analyzing expenses, we can see that operating overhead expenses saw the greatest increase on a percentage basis - with a 23.2% rise from that of Q2 2021.

With distribution and selling expenses having seen a strong increase as a result of inflationary pressures and supply chain issues - further rises in operating expenses could place further pressure on earnings growth going forward.

Looking Forward

adidas AG has seen an encouraging revival in sales in the past year. With that being said, we could now be reaching a point where investors start to pay more attention to bottom-line metrics such as earnings and cash flow. While sales growth is encouraging in its own right - adidas AG cannot ultimately remain profitable if such growth cannot keep up with rising expenses as a result of inflation.

When looking at the company's P/E ratio - we can see that while the ratio is trading at a five-year low - earnings per share (on a normalized diluted basis) has also been seeing a decline from the highs reached in 2021.

Rising expenses and higher inflationary pressures - coupled with a potential lull in seasonal demand as the summer months draw to a close could mean a further plateau in earnings growth heading into the winter months.

Conclusion

To conclude, adidas AG has shown an encouraging revival in sales growth. However, such growth has been accompanied by higher expenses driven by inflationary pressures. My view is that while the stock continues to have long-term upside potential - investors will pay more attention to earnings and cash flow growth going forward.

Additional disclosure: Long Adidas AG (ADS:Xetra) stock as listed on the German XETRA exchange. This article is written on an "as is" basis and without warranty. The content represents my opinion only and in no way constitutes professional investment advice. It is the responsibility of the reader to conduct their due diligence and seek investment advice from a licensed professional before making any investment decisions. The author disclaims all liability for any actions taken based on the information contained in this article.

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