Adidas

Stock price: €42
Conclusion: Slight rebound at Reebok combined with a strong dollar lead us to upgrade our valuation range to €43-€45 per share. Nonetheless, we think Puma offers higher re-rating potential.

Q1 results: Sales up 4% to €2.6bn-Net income: €168m (€5m last year) EPS guidance 2010 raised to €2.05-2.30.

Looking for mid single digit organic growth in sales.
-Growth held back by wholesale. Sales increased by only 1% in Q1, impacted by lower revenues in China where Adidas lost share against Nike, Japan and Emerging Europe. The environment remains fragile in Europe with weakening consumer confidence in May. China is expected to be stronger in H2, following inventory clearance in the first half of the year. Sales should continue to be positively impacted by the FIFA World Cup in Q2 and Q3.
-Retail up 16% in Q1 (2228 stores) could grow double digit this year helped by store expansion (125 new stores in emerging markets) and mid single digit growth in comparable store sales.
-We expect both Adidas and Reebok to increase sales this year, albeit at a lesser rate for Reebok. Although the toning category is doing well, Reebok continued to report weak sales outside the US, notably in China and in Latam.

Management could further upgrade EPS guidance.
-Reported sales could grow almost double digit to €11.3bn, boosted by a weak euro.
-Gross margin could reach the top end of management forecast (around 47.4%), driven by lower input costs, faster growth in retail, lower level of clearance sales and a stronger Ruble. Adidas is 100% hedged for 2010 ($1.38), at rate slightly less favourable than in 2009.
-Operating expenses will benefit from positive leverage combined with headcount reductions in wholesale, offsetting higher marketing and retail spending. Operating margin could improve to 7% of sales.
-EPS could reach €2.36 in 2010, exceeding the top end of Adidas guidance ($2.05-2.30). 2011 outlook looks uncertain for two main reasons, first sourcing costs could be under pressure ( dollar exposure only 50% hedged), second the market remains very price competitive.

Adidas trades at 17.8x P/E based on 2010 estimates, implying 18% premium to Puma. A further rerating would require to bridge the margin gap between Adidas and Reebok (10 points ), which might take time. We favour Puma which is valued at lower multiple coupled with structurally higher margin.

Adidas

Stock price: €36.5
Conclusion: Lack of visibility for Reebock coupled with disappointing margin forecast for 2010 lead us to confirm that the stock looks fully priced. We slightly downgrade our valuation range to €37-€40 per share.

2009 results: in line with guidance. Sales down 4% to €10.4bn (-6% organic- flat in Q4). EPS down 60% to €1.22. Guidance 2010:low to mid single digit growth in sales -EPS to increase between €1.90 and €2.15.

Reebock’s lack of visibility
Sales declined 7% last year against a 5% decrease for Adidas. Q4 was better with 4% growth in the US, but more than offset by lower sales elsewhere (Reebock sales down 1% in Q4). Reebock looks too small to compete against iconic brands such as Adidas, Nike or Puma and too big to hold a distinctive niche positioning. Moreover, the new reporting structure which concentrates on channel rather than brand profitability does not send a positive signal to investors. Management expects Reebock to return to growth in 2010, thanks to new training shoes concepts such as Easy Tone and Zig Tech supported by increased communication spending. However, Adidas warned that growth should be skewed towards H2..

Disappointing margins outlook
Notwithstanding an expected positive swing in sales growth from -6% in 2009 to mid single growth in 2010, combined with positive hedging and lower input costs, Adidas projects only 6.5% operating margin against 4.9% last year. We think that earnings recovery could be held back by three factors:
-Continuing pricing pressure in mature markets
-Higher media spending (down €160m last year to 12.2% of sales) in anticipation of the FIFA World Cup. Management expects to exceed €1.3bn sales in the Football category.
-Higher retail investment (150 new stores and 200 remodellings), combined with spending in a new retail organisation.
Net earnings will benefit from lower financial expenses related to the net debt reduction to €917m (down €1.2bn in 2009). We are looking for €2.17 EPS this year, the top of the range of Adidas estimates for 2010.

Adidas trades at 16.7XP/E and 8.7XEV/EBITDA based on 2010 estimates, implying almost 20% premium to Puma. Our valuation range (€37-€40 per share) suggests little upside.

Adidas

Stock price: €38

Conclusion: The stock looks fairly valued based on our valuation range of €38-€42 per share. Uncertainty regarding Reebok should prevent short term re-rating. We prefer to invest in Puma which trades at a similar 15x P/E multiple based on 2010 estimates.

9 months: net sales down 3.7% to €7.9bn (-7% like for like), EBIT down 52% to €465m, net income down 62% to €226m. Full year guidance : €1.15-1.30 EPS (€3.1 EPS in 2008).

A temporary setback for Adidas and Taylor Made
- 2009: A Perfect Storm
Management confirmed that EPS should fall by 60% in 2009, as a result of unprecedented challenges. Lower demand and downtrading for sporting goods everywhere except in Latin America, combined with excess inventories in the US, Europe and China. Rising input costs, restructuring expenses in Europe and in Asia, integration costs following the acquisition of Ashworth, and structural difficulties at Reebok.
The only good news comes from the cash management, as cash flow from operating activites was €122m vs €100m outflow at the end of Sept. 2008, and net debt decreased €299m to €2.3bn (end Sept).

- 2010 to benefit from improved costs structure.
Notwithstanding the expected positive impact of the 2010 world cup, Adidas might continues to feel the pressure from low consumer demand, while retailers want inventories to remain under control. However, gross margin in 2010 will benefit from the impact of less inventory clearance combined with lower input costs. In addition, Adidas should reap the fruits of the new operating structure announced in May: elimination of regional offices and implementation of joint operating models in Europe and Latin America.
We expect sales to increase by 3% but EBIT to reach €880m vs €547m projected in 2009, and EPS to rebound to €2.46 per share.

Far less visibility on Reebok
Adidas has not been able to turn around Reebok, acquired in 2005, neither in good nor bad times. We expect Reebock to report €140m losses in 2009. Reebock struggles to find a positioning between iconic brands such as Nike, Adidas and Puma. As a result, pricing power is weak and leads to depressed gross margin (30% vs 46% for the Adidas brand).
We think that management should refocus on Adidas and Taylor Made, which implies a risk of impairment (€425m goodwill in Adidas balance sheet).

Adidas trades at 15.3x P/E and 8.4xEV/EBITDA based on our 2010 estimates, at a slight premium to Puma. We don’t think that Adidas is expensive based on our valuation range. However, investors might prefer to invest in Puma as long as Reebock remains an issue.