The Motley Fool

3 Reasons to Buy Adidas

Photo: David Schiersner @ flickr

There is no denying: Adidas (WKN:A1EWWW) (ETR:ADS) (FRA:ADS) had a miserable 2014. A 40% drop in the company’s share price made it the worst performing DAX stock of the year. However, one bad year does not necessarily mean long-term underperformance. In fact, last year’s losers often turn into this year’s winners.

In recent articles I have looked at the key reasons for the disappointing performance in 2014 and my expectations and concerns for 2015. While these articles mainly focused on the significant challenges ahead of the German company, there are also possible reasons for buying Adidas shares. Here are the three key reasons.

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Valuation

As the below table shows, Adidas is significantly undervalued not only compared to its main competitors Nike (WKN:866993) (ETR:NKE) (NYSE:NKE) and Under Armour (WKN:A0HL4V) (FRA:U9R) (NYSE:UA), but also compared to industry average:

P/E Ratio Price to Sales Price to Cash Flow
Adidas 18,6 0,81 13,43
Nike 28,6 2,79 23,20
Under Armour 79,8 5,03 57,50
Industry 27,6 2,33 20,70

Source: Finanzen.net, OnVista.de, caps.fool.com (11/1/2015)

Ratios for Nike, the established industry leader, are slightly above average. For Under Armour, the newcomer, they are significantly above industry average, reflecting the very high growth expectations for the company. Adidas’ ratios, however, are significantly below both industry average and its competitors — it doesn’t matter whether the ratio compares the share price to sales, earnings or cash flow.

Based on this, Adidas‘ shares look very cheap; and since these ratios reflect 2014 estimates, any improvement in the results of 2015 would make the share price look even cheaper.

Favorable industry dynamics

The global sportswear market is large and is growing at a healthy rate. According to a recent market study by Catalyst Corporate Finance, global retail sales in the sector were $263 billion in 2013 and are expected to grow by 7.5% annually between 2013 and 2017. This growth is driven by powerful long-term trends: Consumers are becoming increasingly focused on healthy living and active sports participation rates — especially among women — are rising. Customers are also willing to pay more for innovative, technologically advanced products (for example, breathable fabrics).

Also, while the US remains the most important sportswear market by size, sportswear is increasingly becoming a global, emerging markets story, as the below table illustrates.

2013 sportswear sales, $billion 2013-2017 annual growth forecast
North America 91 3.7%
Western Europe 53 4.0%
Eastern Europe 16 13.6%
Asia Pacific 56 8.9%
Latin America 28 16.6%
Middle East/ Africa 15 10.1%
Australasia 4 3.1%

Source: Euromonitor

Adidas, the second biggest player globally, is in a good position to benefit from these market trends.

Emerging markets dominance

While Nike is the industry leader worldwide, it is often overlooked that in the emerging markets — that is, outside of Western Europe and North America — Adidas is the number one player. In these markets, Adidas had €7.5 billion sales in the last twelve reported months, while Nike had only about €6.8 billion sales. Adidas’ dominance is especially visible in Eastern Europe where the German company sells almost twice as much as its American rival. China is an exception; here Nike is slightly ahead.

This is important because as mentioned above, the emerging markets should be the real source of growth in the long term. In these markets, population is growing faster than in North America and Western Europe. This, coupled with more and more people moving from poverty into middle class, will result in higher growth in consumer spending.

One note of caution: Nike is closing the gap. Over the last twelve months, Nike grew sales in the emerging markets by almost 8%, while Adidas by only 2%. In other words, the German company is losing ground not only in its core markets, but also in its growth markets.

Foolish Conclusion

Adidas had a rough 2014 and it has still many challenges ahead. However, there are also compelling arguments for buying shares of the company. It has a strong number two position in the large sportswear market, which is growing at a healthy clip. In fact, it is the biggest player in the emerging markets, where future growth lies. Also, Adidas is significantly undervalued, both compared to its competitors and the industry average.

There are, however, still many concerns around the company. Our next article will highlight the three reasons to sell Adidas shares, so stay tuned to Fool.de to find out more.

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Miklos Szekely does not own any of the stocks mentioned. The Motley Fool recommends and owns Nike and Under Armour.

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