ADDDF - adidas: Turnaround In Progress

2023-04-18 04:46:58 ET

Summary

• adidas’ Q4 ‘kitchen sinking’ has bought new CEO Gulden time to right the ship.
• In the near term, working through the Yeezy inventory issue is top of mind, while in the mid term, efforts to accelerate organic growth and regain market share are key.
• With the stock now re-rated to a relative premium, the risk/reward of underwriting the adidas turnaround isn’t ideal.

After a slew of profit warnings in 2022 and a big 'kitchen sinking' reset in Q4 (see my prior coverage here ), investors seem to have turned optimistic about adidas' ( OTCQX:ADDDF ) Bjorn Gulden-led turnaround. Assuming adidas follows through with a big demand creation push (i.e., marketing and product innovation) to regain brand 'heat,' a clawback of the market share lost to sector leader NIKE ( NKE ) seems inevitable, with early signs pointing to 2024 as the inflection point. But betting on a turnaround strikes me as premature at this point - with no mid-term plan outlined yet, the shape and magnitude of an earnings recovery are tough to gauge. Further, shares have already been re-rated to a P/E premium vs. key peers NIKE and PUMA ( OTCPK:PMMAF ) on FY24 numbers, unfavorably skewing the risk/reward. The Q1/Q2 results in the coming months will shed some additional light on the fundamental progress. But the key catalyst won't arrive until this summer's Capital Markets Day event when the mid-term brand and margin recovery path will finally be laid out.

No Surprises in Q4 Following the Pre-Release but No Recovery Signs Either

There wasn't a lot for investors to chew on at the adidas Q4/FY22 results announcement . Following the prior profit warning , results were in line with expectations, while management offered few insights into an updated FY23 guidance or the turnaround plan. In the near-term, inventory remains the biggest drag on the P&L. The Q4 numbers showed adidas is a long way from fully clearing out its excess stock (>170 inventory days), particularly in the key North America and China regions. Of note, another EUR500m of one-off charges are likely to be incurred if the existing Yeezy inventory on hand (EUR1.2bn worth) isn't repurposed. Given order volumes have shown few signs of picking up thus far, offering little respite to the excess wholesale restocking through 2022, all signs point to more markdowns for H1 2023 as well before normalizing post-H1.

The qualitative takeaways were more encouraging - per the FY22 statement, new management sees a line of sight to adidas turning into a "profitable business by 2024." Unsurprisingly, efforts to refocus on product, customers, distribution, and athletes/communication were cited as the key P&L levers. But this is relative to a low 2022 base; with 2023 also set to be a heavy investment year, the shape of a potential margin recovery remains unclear. From here, all eyes will be on CEO Bjorn Gulden's update on the adidas brand turnaround, with more details expected at the capital markets day presentation (likely in the summer or post-Q2). What is certain is that the previous 2025 EBIT margin target range of 12-14% (vs. 3% in 2022) will need to be revised downward. Beyond the target numbers, gauging the duration and extent of a transition will be key as well.

Revisiting the PUMA Playbook to Regain Global Market Share

New CEO Gulden has gotten off to a strong start at adidas. Having rallied ~27% YTD, investors are clearly optimistic that he can replicate the successful turnaround achieved at PUMA. If the big pre-Q4 reset was anything to go by, he looks to be continuing his track record of straightforward and conservative guidance at PUMA. For now, the 'kitchen sinking' exercise has bought adidas time to implement its turnaround playbook over the coming months. Topping the priority list will likely be broadening its reach in sports performance (+19% in FY22 vs. -5% for Lifestyle) - like Gulden's success in refocusing PUMA toward sports (from Lifestyle), adidas has ample opportunities to gain share beyond increasingly competitive categories like football and running. And on the execution side, faster, less centralized decision-making, as well as improved 'brand heat' management (i.e., balancing supply and demand via production/distribution), will be top of mind.

In the near term, efforts in dealing with Yeezy inventory will be a key litmus test for Gulden; unlike in North America, for instance, brand 'heat' has been more resilient in Asia/emerging markets, so managing the distribution could pave the way for an early win. Investors have been relatively forgiving on the margin side, so expect new management to take full advantage with ramped-up marketing and product innovation spending in 2023/2024 to regain market share. This leaves any margin expansion likely to be a result of operating leverage (i.e., revenue growth) over P&L efficiencies. Management will still need to deliver on an organic growth acceleration in 2024 (relative to NKE), though, to justify the leeway.

Turnaround in Progress

With Bjorn Gulden starting his reign at adidas with a huge kitchen-sinking quarter last time around, the prospect of further profit warnings has dimmed - at least for the next year or so. Yet, turning adidas around won't be an easy task from an operational or financial perspective. For investors, the scale of marketing spend and brand heat the Gulden-led adidas can generate remains unclear at this point. But given the years of market share losses suffered previously (mainly to NKE), simply regaining some of the lost share would yield a top-line growth reversal as soon as 2024. The catch is the valuation - adidas shares have already re-rated in anticipation of an earnings recovery, with the fwd earnings valuation now at a premium to its sector peers. Pending visibility into the mid-term plan, which likely won't arrive until the Capital Markets Day event in H2/H3, underwriting a brand and margin recovery seems premature at this point.

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