EUR 850.00 For Business Accounts Only

Morningstar | Solid Start to 2019 for Narrow-Moat Adidas Despite Production Issues; Shares Overvalued

Narrow-moat Adidas reported a solid first quarter of 2019 on a gross margin improvement and strength in China. Adidas’ first-quarter EPS from continuing operations of EUR 3.17 beat our forecast of EUR 2.93 as its gross margin of 53.6% was well above our forecast of 51.3%. Adidas’ first-quarter sales of EUR 5.88 billion beat our forecast of EUR 5.79 billion, partly due to currency-neutral sales growth of 16% in greater China. We think Adidas continues to gain share on smaller brands in China, where it is viewed as a premium brand. Adidas, though, is suffering from supply shortages that limited its currency-neutral North America growth to 3% in the first quarter, 1 percentage point below our forecast. We think the continuing popularity of athleisure in the U.S. and elsewhere has surprised even Adidas. We expect the firm to lose as much as $400 million in sales (mostly in North America) due to supply problems this year and expect it will have to ship some product by air. While this will negatively impact operating margins, we think Adidas must maintain share as it faces competition from narrow-moat VF’s Vans, narrow-moat Hanesbrands’ Champion, and other athleisure brands.

Adidas jumped nearly 10% on the first quarter outperformance. However, we think Adidas’ continuing supply problems will offset some of the first-quarter gains as the year progresses. Our 2019 sales and earnings estimates were at the high end of company guidance prior to the first-quarter report, and Adidas did not raise its full-year outlook after earnings. We forecast 2019 sales of EUR 24 billion, an operating margin of 12%, and a net income margin of 8%. We do not expect to change our fair value estimates of EUR 199 and $112 for the German and U.S. shares, respectively. We view Adidas, up sharply this year, as overvalued at current levels.

We think the popularity of Adidas’ celebrity-inspired apparel allows it to reach new consumers and overcome weakness in physical retail. We believe the popularity of Yeezy shoes greatly benefits its e-commerce (up 40% in the first quarter) as some limited styles are exclusively available online. Moreover, we expect Adidas’ new partnership with Beyonce will increase sales to women, which we estimate compose less than 30% of total sales. We think Adidas’ fashionable and innovative product supports its brand power.