Figures in this article reflect prices as of market close on 12/19/2014 unless otherwise specified.
It’s easy to see that 2014 was a miserable year for Adidas‚ (ETR:ADS) stock. But what’s important for investors is to understand why it was such a bad year, and whether the problems at Adidas are fixable or will keep the athletic brand in the penalty box for years to come.
The year was supposed to be a strong one driven by World Cup revenues and Germany winning the title for the fourth time should have provided more cause for celebration (and an additional boost to sales). However, one disappointing quarter followed another, and in late July the company management issued a profit warning for 2014. Adidas also acknowledged that the 2015 long-term goals would also not be achieved. As a result, the share price dropped sharply and — apart from a brief rally after third quarter earnings — has yet to recover. The stock is currently trading almost 40% below its all-time high, reached at the beginning of the year, making it the worst performing DAX stock in 2014. The below graph shows the dramatic drop over the year:
So what went wrong in 2014? Let’s look at the key reasons that contributed to the company’s dismal performance.
Sales in Western Europe and North America struggled
Adidas has lost a lot of ground to Nike (NYSE:NKE)(ETR:NKE) in the key Western Europe and North America markets, which add up to about half of global sales. The below table shows the year-over-year sales growth for the last three (for Nike, four) reported quarters:
Source: Adidas and Nike quarterly reports; currency-adjusted sales growth vs. prior year
Even though Adidas will report fourth quarter earnings in early 2015, it seems very likely that it has lost the title of #1 sportswear company in Western Europe to its arch-rival. Nike had an extremely strong 2014 in the region and its sales grew by 22% to reach around €4.2 billion. Adidas would have to increase its fourth quarter sales by more than 25% compared to prior year in order to retain its leading position. Based on the last quarters’ performance, such a strong growth is extremely unlikely.
In North America, both Nike and relative newcomer Under Armour (NYSE:UA) (STG:U9R) have outperformed Adidas, pushing it back to third place in the first nine months of the year.
This does not bode well for the German company. Growing in the emerging markets is essential, but having a strong position in one’s core markets is equally important, and Adidas is falling behind in both of its core regions.
A decline in the popularity of golf was hurting Adidas’ golf business
The golf industry is having structural problems. Participation rate is dropping and, especially among young people, there is a growing disinterest for a sport that takes too long to play, doesn’t have the intensity of other sports, and doesn’t have a true star player with major appeal any more.
Adidas, together with other golf apparel manufacturers, started to feel the negative impacts of this trend in 2014. In the first nine months of the year, sales at TaylorMade-adidas Golf dropped by 29% (on a currency-neutral basis) and operating profits were €150 million below 2013 levels. The segment represented 9% of total sales in 2013, so this structural decline will continue to be a strategic challenge.
Business in Russia was negatively impacted by the geopolitical tensions
Adidas has a traditionally strong business in Russia with a network of over 1,100 stores. As a result of the recent geopolitical developments, however, consumer sentiment has been falling in the country. To counter this, Adidas had to rely on strong promotional efforts to clear its inventory, driving down margins. The weakening ruble further decreased profitability.
All in all, the Russia region caused roughly a €100 million negative profit impact in the first nine months. After the development over the last weeks — a further sharp fall in the value of the ruble, coupled with a big increase in interest rates — it is very likely that the coming quarters will bring further negative news for the company.
Currency developments had a significant negative impact on the results
The ruble was not the only currency causing problems. Many currencies across Asia and Latin America also weakened compared to the euro on a year-over-year basis. As a result, while sales increased by 6% in the first nine months on a currency-neutral basis, reported sales growth was only 1%. In euro terms this meant €550 million less in sales due to currency translation. On the profitability side, margins were down by about 50 basis points and operating profits were impacted by roughly €150 million.
In the fourth quarter, the sharp drop in the Russian ruble will cause further translation losses and margin erosion. However, the recent strengthening of the US dollar should bring some positive impact to the North American market, as every US dollar received from the North American customers will be worth more euros.
Financial results of 2014 are worsening
As a result of the above-mentioned problems, the financial performance of Adidas was significantly worse in the first nine months of 2014 than in the previous year. While sales grew by 1%, operating profit was down almost 20%. Operating margins dropped 2.2% points to 8.3%. On the cash flow side, the company used a hundred million euros more in operating activities than the year before.
Full-year results are also expected to follow this trend. While currency-neutral sales are expected to show single-digit growth, net income is expected to drop from €839 million in 2013 to around €650 million for the full year in 2014.
What does all this mean?
After five years of strong share price performance between 2009 and 2013, during which the stock value quadrupled, Adidas had a reversal of fortunes in 2014. Some of this, like the currency developments or geopolitical tensions, is out of the company’s control. However, some other issues such as losing market share in Europe and North America are largely driven by the actions by Adidas and its competitors and are worrying developments for the future.
What should you look out for in 2015? Are there reasons to buy Adidas shares? Are there reasons to sell them? We will look at these questions in coming articles — so make sure you stay tuned to fool.de.
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Miklos Szekely does not own any of the stocks mentioned. The Motley Fool recommends Nike and Under Armour. The Motley Fool owns shares of Nike and Under Armour.