Tuesday, November 29, 2016

On the freight train - how do you value Adidas?

I own a position in Adidas - the German athletic shoe and fashion company.

Given how well it has performed the position is nowhere near big enough.

I wish all my longs had performed this well.

But it poses a fairly typical investment problem for which I have no real answers.



I will give you a very stylised history of how we got here.

Herzogenaurach in Germany is a funny (and small) town quite close to Nuremberg - and a couple of hours drive north of Munich.

Once upon a time two brothers started a sports shoe company (and it was successful). The brothers split up and one brother started another sports shoe company.

Those companies are Adidas and Puma. And for a long time they considered each other the enemy.

Then along came Nike and especially the Michael Jordan partnership and basketball shoes - and exposed Herzo for what it was - an out-of-touch German backwater.

Bluntly the fashion path in shoes was from (mostly African American) street wear, to middle-class white street wear to China (where the affluent to a surprising extent mimicked American fashion). And basketball shoes were the path to cool.

Sure there were some people I knew who went to Wharton who thought Puma was some kind of Euro-elite cool - but frankly the Germans just missed out.

I went to Herzo to visit these companies because they were super-cheap (and for no other reason).

How did I measure cheap?
These stocks were just cheap against revenue really. Nike - by far the leader - has a market cap of $85 billion down from well over $100 billion.

It has a bit of net cash (reflecting how insanely profitable it is) and about 33 billion of revenue. The price is about 2.5 times sales - but when I went to visit Herzo Nike was trading over three times sales.

By contrast Puma (which is essentially in the same business) has a market cap of €3.5 billion and sales of about the same. It is roughly 1 times sales. When I went to visit Puma was trading at about 0.6 times sales.

Relative to sales Nike had something more than five times the valuation of Puma. This gap has now closed a lot.

But then again Nike was (and remains) insanely profitable and Puma just wasn't.

Adidas was somewhere in the middle of these valuations.

If Adidas or Puma could sell shoes at something like Nike's effective margin then the German companies would go up. A lot. An insane lot. Like 5 baggers were on offer.

But then Adidas and Puma had just missed the boat. And whilst they had decent positions in European fashion (driven by strong positions in what Australians and Americans call "soccer") they had meaningless positions in America and weak positions in China.

Now fashion is not an area I have any expertise. This is obvious if you see how I dress.

So I was not likely a buyer. Just kicking the tyres.

The Puma shop in Beijing

But I still wanted to kick the tyres. After all cheap is fun - and I am a value investor. So I did make a point of walking around Puma and Adidas shops in various locations, and even counting customers vs. say local Nike shops.

Most the shops however are like shops on "Fifth Avenue". They are meant as much as anything to be brand advertising rather than to make a profit in their own right. So this is still only marginally useful research.

That said I went to the Puma flagship shop in Beijing - and - with a translator - interviewed the staff. I wrote out the impressions in an email to Michael Lämmermann, Puma's CFO - but mostly because I had his email somewhere in the system. Here is that email:

I have just come back from a work trip to China. 
I wanted to leave you impressions of the Puma Shops in Beijing and Shenzhen which I spent some time looking at. 
Beijing is a disaster area - very badly run by surly staff. 
This is a fitness company and the staff were fat. Not obese - just pudgy - but they did not look like they used the products and they did not present an image that would sell the product. 
We asked them (in Chinese) how they were employed - and it was from a local staff pool. They were Beijing locals (more expensive) but that was the end of it. 
This is a country where it is legal to ask women to send in photos with their job applications and to just choose the prettiest one.  
Whatever - fat staff in a sporting good shop is a really bad image - and you need to fix it.
Fat and rude staff is just unforgiveable. 
Shenzhen (Dongman district) was better. The kid behind the counter (only one of them - shop was small) looked the part - and was wearing your shoes and looked young and fit. 
He was also helpful to our (very fluent) Chinese speakers in the group.
However he was wearing non-Puma track clothes. Just saying. 
For the record - I have not been convinced enough to buy your shares - but they look cheap. 
This was just observation.
I did not get a reply.

And I have never touched Puma stock.


Enter Kasper Rorsted at Adidas

Adidas got an activist shareholder - one with a longer-than-average time horizon. This was Groupe Bruxelles Lambert - the holding company of Albert Frere and the late Paul Desmarais. I have watched GBL for some time.

GBL are soft-cooperative activists in the Northern European sense. They tend to get what they want cooperatively and slowly - often very slowly.

GBL agitated for and got a new CEO at Adidas - a Dane named Kasper Rorsted.

We knew him. And I have thought him pretty darn good for a long time. He was the longtime CEO of Henkel (a Munich based industrial glue and consumer goods conglomerate). Henkel was the second biggest stock at the foundation of Bronte Capital - and we have held it continuously. [Regrettably I sold too much on the way up.]

Kasper might not walk on water. But he is still in the top league of CEOs. 

So we bought Adidas stock purely on the speculation. After all Kasper had experience in American consumer goods, was a generally good guy and the stock was cheap enough on a price to sales basis that the upside was large.

And the stock has gone up.

In all honesty I do not begin to understand what Kasper has done that has made this company better - but it sure shows in the numbers.

Here is an extract from the last quarterly presentation - you can find the link here:

This is a little hard to see - so I encourage you to download the original. But note really nice sales growth in all jurisdictions and sales growth above 20 percent in both the USA and China. 

There is clearly a fashion element here. Adidas has a deal with Kanye re shoes. I am so out of popular culture I needed to educate myself as to who Kanye was. (No I am not joking.) 

But it can't just be Kanye (as the new Michael Jordan no less) because Reebok shoes (also owned by Adidas) are having similar sales volume growth. 

Whatever - Adidas is now growing explosively. 

Take your 20 percent volume growth and stick into a valuation spreadsheet and see what you come up with. This sort of net present value worksheet is like Hubble telescope. Tweak the directions of various variables even a tiny bit and you wind up in a different galaxy. 

So we can't value it. We have no idea.

But we own the stock. The position is still not enormous (the original holding was a suck-it-and-see speculation on the new CEO) but the position is getting bigger and bigger because the stock is doing well.

I don't want to get off the train. At least until I see something negative. So I am looking for negative. Comments wanted.

Sports rights - the new and increased negative

A re-energized Adidas is the best thing ever if you are high profile sports player looking for a shoe-deal. 

There are now two rich companies wanting to put shoes on your feet and logos on your body. And that means bidding wars.

The insane war for the four big brands of Spanish football (Barcelona, Real Madrid, Ronaldo, Messi) is getting just bizarrely expensive

This is great for people with innate ball skills (which is most certainly not me). It is bad for both Adidas and Nike shareholders. I watch in horror.

But apart from that I can't (yet) see the negatives. But then I have no fashion sense (at all) so I might be the last person to see.



EB said...

Adidas has done an incredible job penetrating today's modern fashion. They have major partnerships not just with Kanye but with other well-known designers (Y-3 among others) and even their in-house designs have done very well (Adidas NMD being the latest success; check out the market prices of some of their shoes that list for <$200 http://www.flightclub.com/adidas). I think they're unafraid to experiment and have created a distinctly "Adidas" image. Obviously they're doing something right in terms of fashion which is translating into sales

Anonymous said...

John - Great post as usual. Kanye has been losing it recently, could be something to watch out for.

CrocodileChuck said...

"Sure there were some people I knew who went to Wharton who thought Puma was some kind of Euro-elite cool.."

Donald Trump??

Anonymous said...

I live in Portland, Oregon, home of the US headquarters for Adidas (and of course Nike). I can't speak to the specifics of the stock or fashion industry. That said, I'm an active runner here and will make some

1. The industry is clearly at a cyclical high right now. There's construction all over the Nike campus (three cranes right now). People are getting hired for every sportswear company and there's clearly money sloshing around -- my running club got a rather nice set of complimentary uniforms recently; other local clubs for example get full kit quarterly. However, I haven't seen any obvious expansion at the Adidas campus off Greeley.

2. I don't know who Adidas sponsors in the United States. Rose? Not a good name currently. Otherwise, the highest profile athletes in the NBA (LeBron, Curry) are other companies. The Timbers (local professional soccer team) is a good sponsorship. My understanding of sportswear was that brands sell association to high profile athletes. I don't know if social media has changed that model.

3. My understanding was that Adidas long has had great technology but struggled with marketing. That may be changing. A friend who used to work there was perpetually frustrated with Nike getting press for "innovation" when Adidas had already been doing the same thing but had never managed to get the word out.

4. The Adidas employee store (50% off all goods) has become much less accessible. It used to be child's play to get a pass. Nike has long adopted draconian policies about access. Adidas has recently began to follow -- I haven't gotten one for some time.

Anonymous said...

Hi John. Although I missed the investment opportunity a year or two ago, the range of Adidas gear today vs 5-10 years ago is chalk and cheese. As an example, plain black Adidas Copa Mundial and Puma King football boots used to be staples of various football codes, now there is no end to the array of colours and styles of football boots endorsed by the world's best players. What Nike discovered with basketball boots - that kids and players are prepared to pay up for variety and individuality (not to mention the joy of emulating your sports heroes by wearing the same gear) - Adidas finally discovered with football boots and footwear generally. A focus on technology and imitation (e.g. Primeknit vs Nike's Flyknit) has also reduced the gap between Adidas and Nike. The collaboration with Kanye has also helped the company succeed in street wear as well as sports gear, just like Nike has done so well. There are plenty of websites where you can bid for a chance to own a pair of expensive limited release shoes, which has powerful knock-on effects in terms of the design and desirability of shoes. Sneaker and leisurewear culture is only getting bigger, and Adidas has done a far superior job of competing with modern designs and materials across its full range of products in recent years. Adidas is a good example of a business that's hard to kill, given its previous poor management. I have no idea how long the momentum will last, but having seen what works there's no reason for the company to retreat to its old ways lacking imagination and innovation. Cheers.

Robert in Chicago said...

On that last point (sponsorship rights): Three aggressive bidders, not two, at least in the U.S. Anecdotally from the uniforms I see on television, Under Armour's share of big-money-team uniforms (both college and professional) has gone from 0% to roughly 30% in about five to seven years.

Fritz said...

I think the turnaround can be attributed to the popularity of Yeezy Boost-type shoes where the sole goes outwards: http://www.ebay.com/rpp/collectible-sneakers/adidas-yeezy-boost

If you look around and you will see kids wearing similar types of shoes. Even Nike has copied this concept in their recent collections. Yeezy Boost have been ridiculously overpriced and ridiculously hard to get a hold of. Many people buy sneakers as collectors items and given the scarce supply, people are willing to pay up for them.

I think the root cause of the recent successes was the 2014 hiring of Mark King as the head of North America. About the same time, Adidas changed their strategy so that branding and product creation would originate from America for products sold in the region, rather than from Europe. The marketing budget was also hiked 50%+ for 2015. Kanye West's Yeezy Boost was released in 2015 and that's about the time when search queries for Adidas shoes went through the roof:

Since Yeezy Boost was released, Adidas marketing campaigns have also become more controversial, upsetting some but definitely getting the attention of young people. Hostile marketing is known to work for brands that function as identity markers. http://metro.co.uk/2016/02/16/adidas-had-the-perfect-response-to-trolls-who-left-homophobic-comments-on-same-sex-ad-5685343/

It is also possible that the share price is reacting to the hire of Kasper Rorsted as a new CEO.

Anonymous said...

"Henkel (a Munich based industrial glue and consumer goods conglomerate)".
Henkel is Duesseldorf based. Munich has enough Dax-companies, it doesn't need another one.

Anonymous said...

Nice (scuttlebutt) analysis,I also have problems analysis this company. My preliminary conclusion is, they appear to do not have a moat.

BTW, Henkel is based in Duesseldorf.

tiru said...

My 2 cents from India.
You might want to look into the Reebok fraud that cost the company a lot of money.

And an update:

Also, the positioning of the 2 brands is very different here - Reebok is fitness, and Adidas is sports, but Adidas Originals is fashion - dont know if they are replicating it all over the world.. Reebok was a very strong brand in India (much stronger than Nike), and I have friends who are big fans of Adidas Originals. They keep Adidas stores separate from the Originals.


Ryan Bloomfield said...

Could it be argued Adidas strength has been due to the brand damage Nike has suffered in the last 15 years, rather than underlying strength in the Adidas business model?

Think Tiger Woods (cheating), Lance Armstrong (drugs), Marion Jones (drugs), Kobe Bryant (sexual assault scandal), Michael Vick (dog fighting scandal), A-rod (drugs) and Justin Gatlin (Drugs).

Although it was a Gatorade ad campaign, to quote a sporting slogan, no one wants to 'be like mike' anymore (although rather than michael jordan, i refer to the above mentioned fallen Nike superstars) thus the weakness in Nike brand ambassadors has seen sales and investor appeal shift to Adidas, who as the number 2 shoe company, appear the most likely to benefit from the Nike stumble (additionally strictly from a sales perspective, have the most ready made global store footprint).

However, does Adidas have the stable of stars to keep this momentum in the next 5-15 years? Given Nike's success was built on their stable of superstars, not how well dressed and fit looking their staff in the Beijing stores were.

I would argue Adidas do not have the stable of stars to maintain their growth.

X Armour are the danger. Signing #1 basketballer - Curry, former #1 golfer - Jordan Speith, #1 tennis player - Andy Murray, and Quarterbacks Tom Brady and Cam Newton amongst others. Additionally they have just signed the MLB uniform deal.

Nike may sponsor Barca. Adidas may sponsor Manchester United. But as you said in your blog, Adidas and Pumas history of sponsoring European football teams, and this has not paid the same dividends of sponsoring USA sporting stars.

Adidas weakness is the strength of X Armour and their roster of athletes.

Side question - if Kanye does make a run for President in 2020 - sounds crazy now, but imagine 4 years ago saying Trump and President in the same sentence - would this be the first time a President has released a line of sneakers?

Anonymous said...

"In all honesty I do not begin to understand what Kasper has done that has made this company better - but it sure shows in the numbers."
Kasper haven't done anything (yet). The one responsible for this comeback is Herbert Hainer, the former CEO. He gave more freedom for the US HQ, mimic Nike strategy to over-index sponsorship with athletes and not tournametns/championships/events, increased overall marketing budget and somehow got Adidas Originals right.
Adidas Originals attrackted non-athletes to the brand and Kayne West and Pharrel Williams really conected with the young consumers.
Plus, the Adidas brand was on the sidelines for so long, but still had a strong brand equity. So their comeback wasn't that difficult, once they got the team and the product right.
I still believe that Nike is a better company, with stronger management and brand.
Nike superior margins really on scale, well-run assets/stores and more importantly: mix of sales (wholesale/own stores).
On EV/Sales Nike and Adidas valuation still disconected (not important), but on a EV/EBITDA, P/E and P/FCF, Adidas is trading at par with Nike. At the same valuation, I prefer Nike.

Harry Lime said...

There are several elements:

- the fashion factor: they are getting fashion designers (eg. Stella McCartney) to design and celebrities to wear that fashion (Kanye, Pharrel, Rihianna... google them :) )

- the soccer factor: Adidas is HUGE in soccer and will always be. They lost some ground to Nike but with big names like Ronaldo and Gareth Bale it has regained some ground.

- the cool basketball factor: hey, the NBA has Adidas manufactoring ALL its kits!

- people get fed up with winners and Nike is no longer the underground it was back in 1990s.


Anonymous said...

Similar to any consumer driven product segment, trends come and go, and Adidas has been the beneficiary of a huge trend from basketball shoes to leisure/lifestyle shoes. The Stan Smith and Superstars have been the driving force, in addition to the Boost line (independent of Kanye). However, what's lost in the general discussion of trends coming and going is the fact that Adidas has become disciplined relative to the supply and demand relationship within the trend. For example, as the basketball trend boomed over the past 2-4 years, Nike (who was the primary benefactor) started generating an increasing number of iterations of each shoe type. What had been 2-3 versions of the KD's, or Lebron's, or Jordan's quickly became 10+ and 20+ versions with an increasing frequency. Nike ended up saturating the market and lost the "scarcity" and "cool" factor. While some of this can be attributed to changing trends, the primary motivation in my view is greed relative to generating the incremental revenue dollar (with sacrificing the brand). Compare this to a recent Adidas launch in the US of a limited edition Boost model, when Adidas produced only 3,000 pairs and the demand came in at 100,000. Adidas is remaining disciplined and therefore the brand momentum is more likely to be sustained. In addition, time to market is absolutely critical, and therefore Adidas's decision to build out their manufacturing footprint in the US should be another tailwind to the brand over time. While Adidas is not a cheap stock, consensus estimates for the next year or two are likely low given the brand momentum and the incremental operational efficiency discussed on the most recent conference call.

Anonymous said...

Manchester United, with Paul Pogba.

Anonymous said...


Old info, but perhaps something of use.

Dmitry said...

It's difficult to find a negative, provided you already have correct (not fraudlent) accounts and they are fine. Thing about "consumer multinationals" which I purely love is, they rarely if ever fail abruptly. It is in a sense easier for them to go UP (by launching new and successfull product / partnership/ad deal or going to new markets) then to go DOWN (which requires a significant portion of their "legacy" cows to tail off on a short notice. Meaning blind and dumb executives and investors, since the writing is always on the wall!)

However, if you are looking to educate yourself further on the matter, I would suggest examining the possibility of "tier-2" manufacturers rising up on the casual running and other "function over form" lifestyle trends being a legitimate threat to nike/adidas.
This is just an anecdotal evidence with me and people I know, but I've seen a LOT of switching to Asics/Succony and exactly zero in reverse direction. (I can also confirm firsthand from own and ex-gf experience these two do make running shoes for imperfect feet/motion feeling more like custom orthopedics then, well, like underengineered overadvertised crap...)
Then again, I don't even know if these companies are actually on the same market. People who care what Kayne endorses and people who care how their feet feels might be altogether different crowds.

t said...

If it's negatives you want then ADS is now more highly valued than Nike on EV/S if you consider their relative EBIT margins. If they both suffer a hit from rising sponsorship fees then this proportionally hurts ADS much more.

Secondly, ADS is clearly saying that they are going to lower the technology in their like-for-like products to offset the FX headwind coming from the USD-based sourcing. This could be a brand destroyer. The CEO of XXL says he sees this coming and is switching from adidas to other brands.

Thirdly, it's worth rereading the last UA conference call where they heavily reset their margin expectations... there is clear readacross to ADS.

Fourthly, look at H&M, Topman etc finally starting to release sports ranges. Competition is increasing from all sides.

For what it's worth, my stylised history of ADS is in 2006 they thought that you could run a fashion business and a 'performance' business separately. Somewhere along they way they learnt that this is wrong. Others in comments have named names; my pick is Paul Mittleman who joined from Stussy, taught adidas how to be cool, and is now at Converse. Herbert Hainer was a disaster, and Kasper has barely started.

Last time I spoke to the CFO he said that they lost share in football in 2q16 because their boots "didn't look good enough." They finally get it -this is a 100% about turn from where they were a decade ago. Given the brand mismanagement over the long term it's amazing that the shares have done so well.

Anyway, adidas understand how to bottle 'cool' now. See this: https://www.youtube.com/watch?v=nWUyeI5TAns

Anonymous said...

Adidas has been a great investment over the few years - there has been a very successful product / design overhaul (see https://www.buzzfeed.com/reggieugwu/the-man-who-made-adidas-cool-again) that has benefited the company as well as the overall fashion trends towards "athleisure" aka wearing cool sweatpants and running tights as fashion (hence the Kanye combo).

What can slow down/kill Adidas?
- Inability to keep up with fashion trends - sneakers are usually released on an annual basis; fashion trends for clothing are much shorter - that impacts product dev, supply chain etc.
- Adidas is dominant in the world's most popular sport (soccer) but Nike has been inching in with sponsorships with Ronaldo and other clubs. Brand loyalty is strong but not immutable.

Another Franklin said...

Your main concern should be competition by specialisation, not by sponsorship. I took the liberty and asked a woman who worked as a sports coach and gym instructor for a over a decade and has tried sports/fitness wear (including promoting them). She used Lorna Jane (women's sports wear in Australia) as an example and how they target mums and sell their products at much higher price than Nike.
It kind of reminds me of that story that Charlie told about the demise of their trade publication business in one of his talks. The competitors beat them with narrower specialization. They had a travel magazine for business travel but someone came along and beat them by creating a magazine that was addressed only to corporate travel departments.

Dom said...

Biggest negative to watch out for is Euro weakness putting pressure on their Gross margin as 90% of their COGS are in USD. I think they hedge 12 months out meaning they will roll into less favourable EURUSD next year assuming Euro stays at current levels which will lead to increasing sourcing costs and given intensified competition they might not be able to pass it on to consumers.

All the best

Dom said...

Watch the Euro weakness. Ads hedges 12 months out but given that 90% of their COGS are priced in USD a less favourable EURUSD rate puts pressure on their gross margin. Given intense competition they might struggle to offset the gross margin pressure via price increases.

Unknown said...

1) I do think Adidas has lot of potential for growing and becoming more profitable. However, with a P/E16 of 28 a lot of profitable growth are already in the price. Compare to Nike P/E 20 and no debt..Yes, if Adidas could become as profitable as Nike then it would be interesting, but it just never has been. ROIC have bben 4-6% for Adiads against Nike 13-17%. Maybe Kasper Rørsted could change it, but I doubt he can turn around the supertanker in just a few quarters - if ever...

2) US market conditions is becoming more competitive in the recent years - look at margin development for Nike and Under Armour. UA will become even more agressive in the coming years also for international expansions.

Unknown said...

There is an interview with CEO Kasper Rørsted in the danish finance newspaper "Børsen". Unfortunately you have to pay to read the interview online, but here is the summary (google translate..):
Danish Adidas CEO: We can do even better - quote
The world's second-largest sports brand, Adidas, has Danish Kasper Rorsted at the helm since October had a gun in 2016 with revenues, which rose 20 per cent. and the share price has jumped 67 per cent. We must be even better if we want to challenge Nike, says the director.
The paper notes.
Despite the good year for the German group, Kasper Rorsted not going to be complacent ears, and he has no doubts about what to focus on the future; Adidas must be better at making money.
- I place much emphasis on clarity, it is important for a company to say what goes well and what can go better. Our operating margin is not satisfactory. It is half of Nike's, and it's not good enough, says Kasper Rorsted to Exchange.
The operating margin, which shows how good the company is to make money on sales, landed in 2016 at 7.5 per cent. for Adidas, while the margins of the US rival Nike was somewhat higher at about 14 per cent.
One of the initiatives that have been launched to raise the margin, is a drastic remedy of sports brand Reebok, where a third of the employees have been laid off.

Unknown said...

Adidas has done an incredible job penetrating today's modern fashion. They have major partnerships not just with Kanye but with other well-known designers (Y-3 among others) and even their in-house designs have done very well (Adidas NMD being the latest success
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Watson said...

Thanks for sharing as always, John. Interestingly, between Nov 2016 (article) and today, Puma's share price tripled, whereas Adidas and Nike doubled. The CFO and CEO were doing something good behind the scenes but not replying to emails.

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