$NKE & Adidas - Conservatism isn't always a good thing

This is not investment advice and is general in nature. Do your own research before taking any positions in the securities listed below

Why compare two companies with >20 analysts covering each of them?

• With >40 analysts collectively looking at $NKE & Adidas, I would not suggest I have an edge over this collective pool. However, there are interesting business/investor lessons which can be learnt from the difference between the two companies

• Before I get stuck in - a reminder - whilst sports apparel companies have very narrow 'moats' as shown by the rise of Shein, GymShark, Under Armour... $NKE & Adidas have remained market leaders for >20yrs. Today - $NKE has c.27% of global sports footwear & Adidas has c.15%.

Note – below when we refer to $NKE = Converse, Jordan’s, Hurley Umbro. Adidas = Reebok, TaylorMade & Rockport

What makes these $NKE & Adidas so different?

• $NKE have way more dry powder/gearing: $NKE raised +$6bn of long-duration fixed debt in 2020 at low levels (WACD of 3.03%) and has the largest cash position ($13bn) whereas Adidas has €1.6bn of cash & yet lower gearing (30% D/E vs 60% D/E for Nike)

• Both buyback stock regularly, but Adidas buys more: It varies over time, however, over 5yrs $NKE has managed to reduce share count by 1% a year vs. 2% for Adidas. Time will tell if $NKE uses excess cash for buybacks instead of more endorsements or M&A

• Adidas won Kanye, McGregor & Williams - but historically they underspent on endorsements: $NKE has the most aggressive sports sponsorship programs ($1.3bn p.a. totalling c. $9.2bn over 5yrs) and whilst Adidas’ figure (c.$0.7b p.a.) and much smaller levels prior to that. Even thought the way endorsements/influencng is done is changing, the need for this spending is not going anywhere for $NKE/Adidas

• Adidas’ GM% is higher but $NKE’s Net % is higher: $NKE GM% is c.46% vs. 51% but $NKE’s net margin 12% vs. 6% for Adidas. The learnings here are:

  • If you lead the North America market, which $NKE does, there can be great supply chain efficiencies

  • Adidas' performance of golf/cycling has been more mixed than $NKE’s dominance in basketball

• $NKE shares have outperformed despite its lack of conservatism: $NKE has many detracting factors:

  • Aggressive revenue recognition: (Sales - realised returns) vs. (Sales - Average Return Rate)

  • Aggressive Remuneration: $NKE's remuneration is heavily skewed to stock payments vs. Adidas which is more generic (30% cash, 70% stock via STI & LTI)

  • Aggressive Trading multiple: 31x Nike vs. 20x Addidas

Despite all this - $NKE has won in terms of share performance

• DTC is operationally hard for shoes. Adidas invest less in tech but did DTC on apparel well: Adidas has higher DTC (c.44%) vs. $NKE's <38%. The interesting parts here are:

  • Adidas management has been very open that "moving to DTC brings greater complexity to bulk shipping vs. individual parcels and greater shipping costs"

  • Adidas is still rolling out small more bricks & mortar stores (e.g. 200 x small single brand stores) because returns/fitting still needs physical stores. $NKE has not done this so far

  • Neither have any intention to onshore any manufacturing to North America with Vietnam, China & Indonesia being the largest areas for their shoe manufacturing

  • Nike has made several strategic acquisitions Datalogue (data science company) Celect (data integration platform) and Zodiac (data analytics company)

    • Adidas has flagged EUR1bn of tech spend but have invested less in tech to date

But despite all that - the margins can be a game changer

• Both companies are performing poorly in China in short term: You could write a whole article on China for both companies, but they have fairly similar stories here

  • Been operating in China for many decades and it reflects 14 & 17% of $NKE and Adidas' revenue's respectively

  • 2021 proven very tough in China for them - Lockdown, FX & Cost Pressures

  • 2020 saw both companies "over-earning" in China (e.g. $NKE was doing >35% EBIT margin vs. low-teens average)

Conclusion: Despite the aggressive financial engineering deployed by $NKE their superior operating margin, partly over-earning in China & part their lead in Nth America, they have a great advantage over Adidas. For both - I am unsure whether China will continue to provide such favourable growth vs. other regions.

Overall, I am more optimistic on $NKE vs. Adidas, because Adidas is further along DTC implementation & does not have the margin. Nor does it have a huge stack of spare cash that $NKE does. I know there is a huge difference in $NKE multiple vs. Adidas, but I do not feel it is completely unwarranted.