Quarterly Outlook
Equity outlook: The high cost of global fragmentation for US portfolios
Charu Chanana
Chief Investment Strategist
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What does German stimulus and US-China tensions mean for Adidas?
Peter Garnry
Chief Investment Strategist
Summary: Adidas has done much better than Nike in the past five years in terms of growing its operating profit taking market share in North America and gaining traction in China. The company announced this morning that its Q2 China sales is above the same period last year indicating that Chinese consumers are favouring Adidas over Nike in what could have a link to the ongoing US-China tensions. Germany's government also announced last night a VAT reduction from 19% to 16% starting on 1 July which will also help Adidas going forward.
Adidas shares are up 1% today outperforming the market due to two events. A German coalition agreed late last night to a new €130bn stimulus package which includes a VAT reduction from 19% to 16% starting 1 July. This will add tailwind for the it German business but even more importantly the German decision could lead to more VAT reductions in other EU countries. However, the most important event was Adidas’ announcement this morning that it’s Q2 sales in China so far is higher than the same period last year surprising the market. This shows the rebound among Chinese consumers but more importantly that Adidas might be favoured by Chinese consumers over Nike products due to US-China tensions.
We mentioned Adidas already back in early March as the stock was part of our ‘bounce back basket’. The stock has lagged behind Nike in the rebound with Nike shares reaching an all-time high yesterday erasing the losses in February and March. Adidas shares have 26% to go before they reach an all-time high. This shows the speculative fever in US equities as we have highlighted over and over again as today’s Chinese numbers show Adidas has a lead over Nike in the world fastest growing and most important consumer market. Shareholders in Adidas can still be content with the fact that Adidas shares have delivered total return of 352% since 1 January 2015 while Nike shares have only delivered 121%.
Adidas had two years of strategic changes in 2014-2015 which then put the company on an aggressive profit trend with EBITDA growing much faster than Nike that got into trouble in its North America market where Adidas began to do better. The recent decline in Adidas EBITDA is because their Q1 ends in March and thus got a larger impact across all geographies than Nike which latest fiscal quarter ended in February and thus only got impacted on its Greater China business.
The key catalysts for Adidas are EBITDA margin improvement although Adidas finally caught up with Nike on operating margins in 2019; the potential is more limited now but direct online sales to consumers is a path to higher margins. On revenue Adidas seems to be enjoying higher growth than Nike and the US-China tensions could add to this spread driven by the China business. For shareholders in Adidas it should also be a comfort that the stock is valued at a 5% forward free cash flow yield compared to Nike’s 2.8% free cash flow yield.
The key risks to consumer stocks such as Adidas and Nike are changing supply chains disruption and increasing costs of product. Prolonged economic recession is also a key risk as economic growth drives consumer spending. Finally valuations on equities are getting elevated and thus investors should be careful not to overpay for future growth.
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