EUR 850.00 For Business Accounts Only

Morningstar | Narrow-Moat Adidas on Track for Fiscal 2018 Targets Despite Weakness in Europe; Shares Overvalued

Narrow-moat Adidas reported third-quarter results that place the firm on track to meet our full-year assumptions that call for currency-neutral sales growth of 8% and operating margins of 10.4%. While revenue growth slowed more than management expected (up 8%) because of weakness in Western Europe (down 1%, 28% of fiscal 2017 sales), the firm’s gross margin outperformed, growing 140 basis points to 51.8% (outpacing our 50.7% full-year estimate). The primary driver for gross margin were sales through brand accretive channels such as e-commerce (up 76%) and direct-to-consumer (up double-digits). While gross margin outpaced our expectations, the firm reinvested the additional margin into advertising (up 7%) and brand development thus crimping the operating profit expansion. We see this as a prudent decision as the apparel industry is highly competitive with minimal switching costs and should help keep the brand fresh in the mind of consumers.

Management provided updated fiscal 2018 guidance, lowering expectations for sales to an increase of 8%-9% (down from 10%), while raising all profitability measures, gross and operating margins up 100 basis points to 51.4% (up from 50.7%) and 10.8% (versus a prior range of 10.3% to 10.5%), respectively. Due to near-term results, we expect to increase our fiscal 2018 gross margin expectations while simultaneously increasing advertising expense to account for continued brand investment. As a result, we do not expect to materially alter our fair value estimate of EUR 155 ($90 per ADR), which is based on our long-term forecast for 5.6% sales growth and 10.2% operating margins on average over the next 10 years.

Overall, we continue to believe the firm has earned a narrow moat through an intangible brand asset. This is seen in the continued expansion of gross margin and full price sales growth in North America (sales up 16%) and APAC (up 15%), while maintaining disciplined inventory levels (down 7%).