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Down 52% YTD, Adidas (OTC:ADDYY) (ETR:ADSGN) has been among the worst-performing apparel giants as it struggles with weakening demand and its most recent controversy involving their Yeezy venture partner Kanye West. Unlike the company's previous 5-year plan, which saw shareholder returns triple and profits reach record highs, the recently introduced 'Own the Game' strategy has seen those returns revert to zero.
The Adidas name has never been weaker due to several headwinds, such as Chinese customers opting for other brands, inflationary pressures in Europe and the US continuing to slow demand, and the shutdown of the growth-driving Yeezy label—not to mention an expensive shutdown of Russian operations.
Adidas is still down 64% from its €319/share peak in August 2021, but that doesn't necessarily make it cheap. The stock has already rebounded by 38% since the Yeezy crisis low of €94/share. Adidas remains the second-largest sportswear company in the world, yet - given the poor state of the business - at €130/share, I think Adidas is no longer a solid growth opportunity.
Source: InvestingPro
Given the profit warnings, Adidas's dismal third-quarter earnings shouldn't come as a surprise. In euro terms, revenue grew 11% YoY to €6.41b, and operating profit came in at €564m, reflecting an operating margin of 8.8%, which isn't bad.
The specifics are less promising. Adidas' operating expenses reflect a company that is suffering not only from the macro environment but also from firm-specific losses. The seemingly positive operating profit hides a 3Q net income from operations of only €66m compared to €479m in 2021.
Overhead operating expenses grew 27% YoY, increasing by 2.8ppts to 31% as a % of sales. This is mainly due to ∼€500m in one-off costs, most of which can be attributed to the company shutting down its Russian operations and other consequences of the weakening economy. Regionally, China was the greatest source of worry, with the key market recording a 27% YoY drop in sales.
Guidance was also disappointing, with FY22 revenue projected to grow at low single digits for an operating margin of only 2.5%. Hopefully, 2023 will see strong bottom line improvement as the €500m in one-off costs will roll off, positively impacting net income.
A quick comparison with Nike (NYSE:NKE)—whose revenue growth and gross margin also fell by a couple of points—shows that the industry as a whole is suffering. Still, Adidas is exposed to certain firm-specific issues that put further downward pressure on the stock.
The biggest challenge the firm faces is the shutdown of the growth and revenue driver that was the Yeezy brand. The partnership, started in 2016 and set to run until 2026, was a bestseller within the sportswear industry and played a key role in attracting future generations of consumers.
Though Adidas does not disclose its Yeezy sales, the specific numbers have been subject to much speculation from analysts globally. Though only a rough estimate, Yeezy sales are said to make up 9% of total Adidas sales. More importantly, analysts estimate that without the Yeezy collection, the company's sales have grown 1%-a-year on average since 2017.
For context, same-store sales growth averaged 7.5% from 2017 to before COVID. Given the 6.5% delta Yeezy accounted for, I think it's fair to say that Adidas lost the most important driver of its business.
Of course, financials are currently very skewed by the pandemic and the gloomy macro climate. Only as things settle will we have a fair understanding of the extent to which this loss will truly impact Adidas. The magnitude of the impact is also dependent on the company's ability to leverage its ownership of all current Yeezy designs, except for the Yeezy name. It is rumored that Adidas will begin selling Yeezy-like shoes by 1Q23.
In early 2021, Adidas presented its 2025 'Own the Game' strategy based on three pillars: strengthening the brand, increasing the consumer experience, and sustainability. China and Africa are expected to be the main growth drivers, with e-commerce playing an increasingly key role in sales.
Despite the bad news, Adidas will benefit from a couple of short-term tailwinds. The upcoming FIFA World Cup 2022 will drive growth in football, with kits and footwear already released and rebounding sales.
The sportswear giant is also making a strong push into the basketball market, which has been historically dominated by US-based labels such as Nike and Under Armour (NYSE:UA). If successful, the initiative could be a big win for the German brand.
In light of the recent chaos, a new chief executive will be brought in as Kasper Rørsted heads for 'early retirement.' According to Adidas's latest statement, Bjørn Gulden - current CEO of Puma - will take over the helm of the business. Having already spent seven years at Adidas during the 1990s, Gulden is incredibly familiar with the sector.
In the aftermath of the Yeezy partnership collapse, Adidas stock has not only recovered all losses but rallied an additional 14%. The name might seem cheap at 12.6x price to EPS (near 2008/2009 levels), but a lot has changed for Adidas this year, and not for the best.
By my account, Adidas has a target price of €138, based on a two-year downturn and using a 7.8% discount rate. Most importantly, I model a 5Y revenue CAGR of only 5.2%, which I think adequately reflects the loss of the Yeezy brand.
There are an array of problems plaguing Adidas around the world, including a falling market share in the key Chinese market, suspended operations in Russia, a significant inventory build-up, and persistent supply chain problems.
Perhaps they are too many, even for the brilliant CEO who led the Puma (ETR:PUMG) turnaround. If you bought the dip a few weeks ago, it might be time to cash in that upside; if you didn't, now is not the time to buy.
Disclosure: The author does not currently hold a position in adidas AG. This article is written for informational purposes only. It does not constitute a solicitation, offer, advice, counseling, or investment recommendation.
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