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Adidas: A Well-Know Brand Selling At A Discount

August 05, 2014 | About:

Adidas (OTCQX:ADDYY) is the sponsor behind the World Cup winner, Germany. Most investors might be enthusiastic about the windfall provided by the World Cup for ADDYY. Nevertheless, the latest profit warning from ADDYY is a great disappointment:

it now expects net profit of about 650 million euros ($870 million) this year, down from its previous forecast of between 830 and 930 million euros.

In addition, revenue growth has been lowered to mid-to-high single digit in 2014 from high single digit. This lower guidance mainly related to operations with recurring nature make prospective investors nervous. However, this short-term issues indeed provide a great entry point for long-term investors to accumulate a high quality brand name stock at a great discount price. From my conservative analysis, I believe that ADDYY, as a business, can generate at least 6% total return per year for its shareholders, which can well cover its 2.5% dividend yield. In addition, when the pendulum swings to the optimistic side, ADDYY can trade towards $54 per share providing a 38% upside potential. This kind of asymmetric risk/reward profile should be sufficient to compensate investors for the short-term issues.

Company Overview

ADDYY designs, develops, produces, and markets athletic and sports lifestyle products worldwide. Its sales compositions are as followings: Adidas (76%), Reebook (11%), TaylorMade (9%), Rockport (2%), and Reebok-CCM (2%). It is also a geographically diversified company: North America (23%), Western Europe (27%), Latin America (10%), European Emerging Market (13%), China (10%), and the other Asia market (16%).

According to the history of Adidas, ADDYY is a miracle in Bern:

Who would have thought that screw-in-studs on lightweight football boots would help write history? When the German national football team faced the unbeatable Hungarians in the 1954 World Cup final, they won so much more than just a trophy. Their unbelievable victory would be heard around the world for decades to come. And it made adidas and its founder a household name on football pitches everywhere.

It is fascinating to read through the history of Adidas. What's more, with the economies of scale to be a $19 billion sales company, 10% of sales results in $1.9 billion marketing budget. The enormous amount of marketing budget helps ADDYY to create substantial entry barriers for its competitors to match.

Management Team

Herbert Hainer has been with ADDYY since 1987. He has experience in different divisions within the ADDYY group and has been the CEO of ADDYY since 2001.

Robin Stalker joined ADDYY in 1996 as head of corporate services and reportings, and he has been the CFO of ADDYY since 2000.

Both the CEO and the CFO have been with ADDYY for more than a decade. Their deep experience in the operation of ADDYY and involvements in various divisions within ADDYY group help them to manage ADDYY more efficiently.

Financial Strength

Based on Egan Jones rating company, ADDYY has a credit rating of A+. According to Yahoo Finance, ADDYY has $1.8 billion cash and $1.95 billion debts. The net debts is a mere $150 million, relative to the $16 billion market capitalization. With the stable free cash flow generation capacity to cover its 2.4% dividend yield, ADDYY should be considered having solid financial strength.

Valuation

5972751-14070008740396118-Gordon-Tam--CF

Source: Gurufocus

It is a great achievement for the management team of ADDYY that the book value per share of ADDYY has risen from $5 in 2004 to today's $17.9. If the book value growth rate continues, the book value of ADDYY will become $25 in 5 years. As shown from the return on equity chart below, ADDYY can earn on average around 15% ROE. Applying 15% ROE on the future book value of $25, ADDYY can generate about $3.8 per year. This implies 10% earning yields assuming that the stock value of ADDYY remains the same.

5972751-1406999058814833-Gordon-Tam--CFA

Source: Gurufocus

In fact, investors should be curious about what is the current earning yield. With average 15% ROE and 2.2x Price/Book Value, the current earning yield is approximately 6.75%, which I consider to be a reasonable valuation for a high quality brand-name stock, ADDYY, with an ever-growing book value over a decade. For a 2.5% dividend yield, ADDYY can comfortably cover its dividend payout by its earnings yield.

5972751-140700165333182-Gordon-Tam--CFA.

Source: Gurufocus

From another perspective, the net profit margins of ADDYY have hovered around 5% for the past decade. With 0.85x Price/Sales, ADDYY can generate a return close to 6% for its shareholders.

As my fellow readers should know my pendulum analysis provided on my Datalink (NASDAQ:DTLK) article, I believe that the pendulum has swung too far to the pessimistic side for ADDYY. The above analysis shows that ADDYY provides a decent return with limited risks for long-term investors. What might be the upside potential if the pendulum swings to the optimistic side? Let's examine the P/E multiple of its peers reported by Barron's below:

The shares (ADS.Germany) lost almost 20% of their value last week, closing Friday at 58.35 euros ($78.36), or 13.7 times forecast 2015 earnings. But they look cheap compared with rivals Nike (NYSE:NKE) at a multiple of almost 23, PUMA (PUM.Germany) at 24, and Under Armour(NYSE:UA) at almost 56.

If ADDYY can trade close to the PE multiple of 23 just like Nike , ADDYY should be worth $54 per share, implying 38% upside potential

Compare Adidas with Under Armour

From the market capitalization perspective, Under Armour trades around 10% below ADDYY. However, if we compare the sales of both companies, we will notice the big difference between ADDYY and UA: ADDYY has 19 billion sales while UA has only 2.6 billion sales. Based on Yahoo Finance's 24.38% growth rate, it will take 9 years for UA to reach the sales level of ADDYY. Although I greatly admire the unimpressive growth rate of UA, I would rather buying ADDYY instead of UA for the fact that I do not want to invest for 9 years in UA so as to match the sales of ADDYY.

Risks

First, since ADDYY has sales all over the world, there is significant foreign exchange risk in the financial performance of ADDYY. Second, ADDYY is subject to the volatile consumer discretionary segment mainly related to sporting goods and apparel. Although the sporting apparel sub-segment is less susceptible than the general retailers in today's highly promotional retail environment, the weak retail environment overall might hinder the consumer sentiment towards spending. Third, there is intense competition mainly from Nike. As Nike has recently increased its market share, ADDYY might disproportionably be impacted regardless of the sporting goods industry performance.

The Bottom Line

ADDYY is a premium brand name in sport. Other than Nike , it is difficult to find a comparable brand. Although I have to admit that the current headwinds might be difficult for most investors to overlook and focus on the long term potential of ADDYY, the valuation of ADDYY, close to 16x PE, is a bargain for an unique brand with a focus on sporting goods. A long history of ADDYY dating back to 1920 is almost impossible to replicate, and I am confident that the long term value of ADDYY will be appreciated by its patient shareholders given its decent earning yields regardless of market condition.

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Comments

drossi
Drossi premium member - 3 months ago

Thanks for the article! Great Stuff!

Do yu see ROA and ROE improving towards margins similars to UA and Nike?

Cheers

Bodgeit
Bodgeit premium member - 3 months ago

I have sold a lot of Adidas clothing over the last six years through my eccomerce site for a college team. The quality has been declining for several years. The clothing material is getting thinner and my cost has been increasing. Likewise, their costs in Asia have be rising. .

Consumer debt to GDP is high and wages are stagnent. Consumer discretionary should have problems for the forseeable future. No one needs to buy and Adidas sweatshirt. The cool kids that have money are buying UA (In the Northeast at least).

I am also seeing a lot of consolidation in licensed apparel retail. So I see compressed margins on the production side and increased pricing pressures from larger retailers in the short to medium term.

Their soccer cleats do seem to be selling well though.

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