Why Adidas Is An Attractive Buy, Even In An Inflationary Environment. (OTCMKTS:ADDDF)

High inflationary environments are often bad for companies. This is well-known. This is due to their higher production and operational costs, and often, their revenues don’t tend to rise.At the same level.

Companies in these situations face a difficult decision. Do they increase their cost according to inflation? They risk losing clients. Or do they increase their cost at a lower rate of inflation and lose some percentage points of profitability?

A company that:

1. High pricing power due to the unique product it offers that is not copied by competitors
2. Possesses a high growth potential because of a favorable macroeconomic trend.
3. Their products are in high demand, regardless of economic cycles.
4. To operate and achieve its growth goals, it requires very little capital.
5. The company’s valuation makes sense.

I will now be discussing adidas (OTCQX.ADDYY), a company I believe meets all these criteria. Unfortunately, due to a combination of unfavorable circumstances, the company’s market valuation is significantly lower that their peers. I will discuss each of the points I have previously made about a good investment in an inflationary environment.

1. This product is unique and cannot be copied by other competitors. It has high pricing power.

This is the most difficult fact to explain, but it is also the most obvious. When we think of sports apparel, we tend to think about Nike (NKE), adidas (OTCPK:PMMAF) and Puma (OTCPK:PMMAF). If you have some experience in the sector, you may also mention Lululemon and Puma (OTCPK – PMMAF), but you might also agree with the fact that the two largest players in this sector are Puma and Lululemon. This has been the case for decades, and it is likely that this trend will continue. This is because sports, just like fashion, are very emotional. People are passionate about their sport and Nike and adidas have done a great job of capturing this passion into their brands.

Market share for sportswear by brand in the top five markets

Author, with Passport Euromonitor data

adidas is also working to improve its sport-inspired products. This product line uses the positive adidas brand image in the sport to make casual fashion items. Originals is the most prominent brand in this market segment, called athleisure. They have collaborated with Gucci, Prada, and will continue to do so with other brands with the goal of “premiumizing” adidas Originals.

Overall, these high barriers to entry translate into higher than average ROICs, and very few reinvestments in their operations and growth. But, we will get to that later.

2. Possesses good growth potential because of a favorable macroeconomic trend

Mordor Intelligence says the market is forSports apparel athleisureOver the next 5 years, is expected to increase at a CAGR 7% and 6.54%, respectively. This higher growth rate than GDP is due to the positive macro trend that reflects rising awareness of health & wellness.

“Rising health, self-consciousness and desire to lead active lifestyles and appear fit are driving consumers to incorporate fitness and sports activities into their daily lives” (Mordor Intelligence2021).

adidas has published its new design taking this into account. Strategic planFor 2025. They stated in this plan that they expected to increase revenues by between 8-10% and increase their operating margins from the current 10% to 12-14%. They plan to increase their income from ongoing operations at a rate of 16-18% per year. They also announced their intention to return between 8 to 9 billion euros to shareholders via dividends and share buybacks.

They expect to achieve these results by:

• Transform your business into a direct-to consumer business. Sales via DTC channels are much more profitable than wholesaler sales. DTC channels will account for approximately half of the company’s net sales by 2025, and more than 80% of the company’s growth in sales by 2025, according to the company.
• Focus on sustainability: By 2025 9 out 10 products will be sustainably produced. adidas plans to use recycled polyester in all its products from 2024. “The communication and marketing of products made from sustainable materials is going to be intensified.” Additionally, product takeback programs for recycled polyester will be implemented on a large scale. (adidas, 2021)
• Invest heavily to digitalize the company: adidas’ retail stores are set up with full-fledged omnichannel capabilities. They will invest more that 1 billion in digitalization of the entire value chain, from now until 2025.

Although this plan may seem ambitious, I am confident that the company will achieve these excellent results. They exceeded their expectations in every way. Strategy plans from the pastNamed “create the New”. They stated in 2015 that they would increase their revenues to the high single digits, increase operating margin to 10%, and increase net income from continuing operations by 15% per year. Except for 2020, which was an exceptional, average sales growth was 12% per year. In 2019, the operating margin was 11%, and net income from continuing operations was 28% per year.

3. Their products are in demand regardless of economic cycles.

Although it may seem that adidas doesn’t meet this criteria, it is not true. It is possible to believe that sportswear spending will decrease if the economy turns.

Let’s take a look at adidas’ past 3 crises: 2008-2009 (or 2011, or 2020) to see if we can make an accurate analysis.

Author, using data from Seeking Alpha. Annual reports

If you exclude 2020, which was a very difficult crisis that saw adidas have to close almost all of its stores for the year, it is clear that adidas is quite resilient to crises. Their revenues dropped to single digits during the 2008 economic crisis. In the euro debt crisis, they even saw their revenues rise by 11.1%. It seems that the company’s cost structure is quite healthy and can still be profitable, even though its revenues are decreasing significantly year over year.

It is likely that this is due to the emotional attachment sports brands have. People might still be interested in buying the new jersey for their favorite team or the shoes of their idol.

4. To operate and reach their growth goals, they require very little capital

This is especially important in high inflationary environments. This is because companies that need a lot of capital for their operations have a difficult time making new investments to replace old equipment. This is the case with This is not true for adidas. They outsource all their production to other manufacturers. Their main assets include their offices and stores (4,825B EUR), inventories (4.009B EUR), cash and short term investments (3.899B EUR).

This results in high returns for invested capital which means they need to grow with a much lower amount of capital than average. This asset-light company has a low ratio between cash flow from operations and CAPEX. A low relationship between cash flows from operations and CAPEX means that their cash-generating abilities won’t be affected by high levels of inflation.

Author, with data provided by Seeking Alpha

5. The company’s value makes sense

All of the previously mentioned characteristics also apply. adidas competitors. All three are great businesses, with strong brands, high returns on capital, and predictable revenue. This is why I consider all the companies attractive investments. We would still choose the one with the highest risk-reward profile. The one that is less expensive than what we get by buying a portion of the business. We will make a comparison of the valuations of all three. adidas’ competitors.

Author, using data from Seeking Alpha and TIKR

As you can see, adidas is the company that offers the best risk-reward ratio. It has the lowest PEG ratio, and the lowest P/FCF. Even though their numbers are higher than the industry average, they still have the lowest PEG ratio.

Reason for the discount to peer

You might be thinking, “There might be a cause for this discount since…” adidas is a company with high market capitalization. Finding market inefficiencies at that level is very difficult as there are many institutional investors following the stock. We are going to discuss the main reasons behind this discount.

1) China’s difficult market environment: This is the most significant risk in the thesis. Because of the boycott in the past year, adidas has struggled to compete on the Chinese market. The long story short: adidas and other fashion brands opted not to use Chinese cotton as these workers were treated in an unethical manner. Chinese people created a response. Bossa NovaWhich influencers are most influential? adidas sponsored ended their contracts, and there was a disinformation campagne against adidas and their products. This led to a significant decline in revenue in China for the company by 2021.

The company claims that they have made some progress in this area by gaining contracts from new influencers, creating a range of products with Chinese materials, as well as other actions. My opinion is that the worst is already happening and it is already being reflected in. adidas’ current financial numbers. Many others have experienced similar situations. They even announced on their last conference callThey expect to increase revenues in China by the mid-single digits. This is a lower rate than market but it also indicates that the situation has improved.

2) Russian invasion of Ukraine: This risk is one that the market has overreacted to, in my opinion. This is because adidas shares have plunged more than 8% in the time since the announcement of war. Only 2% of the total revenue of the company comes from adidas sales in the region. This is a problem that all companies in this sector have to deal with. This is not a reason to discount valuations between companies.

3) Supply chain issues All companies were affected at the same time and it is already incorporated into the share price and financial results. There are better chances of the supply chain problems improving than getting worse. This is because governments all over the world have made it their top priority to address this problem.

Conclusion

adidas is a classic example of how to invest in a franchise business. It has a strong brand, which requires very little capital in order to operate. It has high growth potential and predictable cash flow. A combination of temporary unfavorable factors has resulted in a lower valuation than comparable companies like Nike, Lululemon and Puma.

It is also a good hedge against inflationary as well as non-inflationary environments due to the nature of a franchise company. All of these reasons are why I believe it is a good idea to start a franchise business. adidas offers investors an opportunity to generate good returns and low risk with an asymmetrical investment.