ADDDF - adidas: I'd Prefer To Buy One Of Its Competitors For The Long Term

2023-06-23 10:17:45 ET

Summary

• adidas is in a difficult spot right now because of the Kanye West and Yeezy situation.
• However, it appears the new management team has a strategy to better position the company for the future.
• Nevertheless, I believe that one of the competitors is a higher quality company and at the moment the better long-term choice.

Thesis

The adidas ( ADDDF ) and Kanye West partnership began in early 2015 with the Fall 2015 collaboration . And the partnership had been a huge success, as Yeezy shoes have been and continue to be some of the most sought-after sneakers in the world. However, the partnership came to an end in October 2022 due to anti-Semitic comments made by Kanye.

And the period from 2015 to the end of 2021 has really rewarded shareholders, helped by the success of the Yeezy, NMD and UltraBOOST shoes.

However, in my opinion, adidas has not managed to build enough franchises other than Yeezy and maybe Superstar. Nike ( NKE ) has done a much better job in that regard and that is their advantage at the moment.

Therefore, I would argue that adidas could be a short-term trade until they get back to their old highs, but in the long-term Nike's prospects are much better.

Analysis

adidas, like many of its competitors, is moving towards more DTC as they try to cut out the middleman to get better margins and also to be closer to their customers. And this is difficult for retailers like Foot Locker, (FL) which I wrote about here , because they are losing business, and also because of this transition, manufacturers like adidas and Nike are now taking on the risk of inventory, and that is showing up in rising inventories for the time being.

Of course, the move to more DTC is not the only reason for the increase in holdings. The general state of the global economy has also played its part. However, it will be interesting to see if this move towards more DTC is the right one, or if it will be short-lived as manufacturers realize they can still benefit from retailers. My view is that it is the right move and that more and more business will be done on their own websites, especially when items arrive in 1 day and the returns policy is simple and efficient.

Nevertheless, adidas is a bit of a turnaround play at the moment, having suffered from the Kanye situation, but in the Q1 earnings call they mentioned that despite the lack of Yeezy sales, sales were still roughly flat. But with their new CEO, Gulden, who did a good job at Puma (PMMAF), they are trying to turn things around.

As you can see above, gross and operating margins have suffered in the past year, but this is only temporary as adidas is probably still the number 2 in the sportswear industry behind Nike. Most of the margin decline is due to write-offs and discounts, and this is likely to continue for some time into 2023. But, and I will talk about this in more detail later, Nike has done some things much better that have given them a strong advantage over almost everyone else in the industry. So I can see adidas returning to their old strength, but I cannot see them becoming number 1.

Leverage has also worsened, but with cash flows normalizing , deleveraging should not be a problem.

Peer Comparison With Nike and Puma

Nike's biggest advantage over adidas and Puma is that they have been able to establish some franchises that are now all-time classics. Nike's Dunk, Air Force 1 and Jordan lines are the ones they established and adidas could only counter with the Superstar collection in my opinion. Puma does not even have a collection where I would say they are on the same level.

But even the Superstar is very cyclical, and the NMD and UltraBOOST have yet to prove that they can be on the same level as a franchise in the long term. But Nike also has the AirMax collection, which was very hyped for a while, so they have really been able to establish those brands, which has given them a big competitive advantage.

adidas is currently trying to establish the Samba, Gazelle and Campus styles and is having some success as you can see on StockX, but it will be interesting to see if this is just a short-lived trend. In my opinion, the designs of the Nike shoes are better and more timeless. Of course, this is a subjective opinion and other people might find the adidas designs better.

Sponsorships/Collaborations

With Bayern Munich, Real Madrid and Manchester United (MANU), adidas has the 3 teams with the most shirt sales for whom they produce and sell shirts. Furthermore, they have a contract with Messi, who will play for Inter Miami next season, which is likely to result in additional income from the US. However, apart from Messi, their list of superstars is rather modest. Benzema and Bellingham are top players, but Nike has signed almost all the other top players apart from those two. In the basketball division, they only have Lilliard and Mitchell, who are good but in my opinion a step below players like LeBron, Curry or Durant in terms of reach and influence.

But with Bad Bunny and Pharrell Williams they have two very influential celebrities, and maybe we will see Louis Vuitton (LVMHF) and adidas working together in the future because of Pharrell.

Two other collaborations that I find really interesting are the Kings League, which has been really hyped on Twitch in some parts of Europe and South America and could bring a fresh breeze to the football scene. And the LesMills collaboration, because LesMills has been very successful in the gym space. Both could help boost sales in the future, as the Kings League in particular has a lot of potential.

ROIC Analysis

On average, Nike has about 10% better ROIC than adidas and Puma and after subtracting the WACC, Nike probably has a double-digit ROIC-WACC spread, which is a clear sign of a high-quality company. Not many companies are able to achieve such results over this kind of time.

Margins

The long-term trend in margins also paints the same picture as the ROIC trend, that Nike is the highest quality company of the three, most likely due to its better perceived brand and slightly more pricing power. If a company has the better margins and returns on capital over a 10-year period, it must have some sort of competitive advantage that it has been able to defend successfully.

Conclusion

All in all, it has to be said that the footwear and apparel industry is a difficult one, as you always have to be on your toes to create new trends or follow the trends in order to serve the buying public. Furthermore, there are no real barriers to entry and there is always the threat of new companies stealing some market share. Under Armour (UA) and Lululemon (LULU) were companies that did this in the past, and today you have On (ONON) as a new, fast-growing competitor in footwear.

However, I believe that adidas will be able to defend its number two position over the next few years and perhaps even challenge Nike. The new management team at adidas and their new strategy of trying to build some franchises could bear fruit in the long run.

The Nike Zoom Mercurial is the most popular football boot at the moment , but the adidas X is not far behind, and I could see adidas becoming the leader again, as they have been in the past. So adidas clearly has some opportunities to gain market share. But overall, in terms of future growth opportunities and brand power, I think Nike is the better long-term option today.

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