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Adidas - A manifesto for investor returns

For the many, not the few
Between luxury and mass-market, there is a segment that marketers call “masstige” –prestige for the mass market – which is defined as “premium but attainable” according to Chi Chan and Martin Todd, European Equities Portfolio Managers at Hermes Investment Management. This usually refers to a dilution of a high-end brand (think of the diffusion lines like Armani Exchange for Armani or Miu Miu for Prada), but it can also be the upscaling of a mass market category.

Due to their high prices, traditional luxury goods can only target a tiny proportion of consumers in emerging markets. By contrast, branded sporting goods like Adidas can offer their products at a premium to the mass market because of their sponsorships, endorsements and technical innovations.

It was this thesis of “luxury goods for emerging markets” that first led us to invest in the Adidas shares in 2009. Adidas’ strength in the football market at a time when the sport was experiencing a surge in popularity in China has resulted in sales more than tripling there. It represented more than 15% of the group last year and the continued rapid growth means this is set to rise further.

North America is the biggest sportswear market in the world, and has also been one of most difficult for Adidas to gain traction in. An increased focus on the region two years ago is paying dividends with the Superstar becoming the most popular sneaker there – the first time in more than a decade where Nike didn’t hold that spot –resulting in sales growth of 31% in the last quarter.

Strong and Stable
There are concerns that Adidas’ resurgence has been purely down to catching the imagination of fashion-leaders and that disappointment will follow when consumers’ fleeting attention spans move onto the next hot item. While it is true that the trend for classic/retro trainers, such as the Superstar and Stan Smith models, has been very beneficial for them, Adidas has much more going for it than that.

More important than “this season’s colourways” is the increasing acceptance of sportswear in social settings. The former is a fad that changes with market whims while the latter is a structural shift whose impact continues over many years.

People dress within social conventions; a hundred years ago a man was not dressed without his hat and sixty years ago, a suit would be the norm. While it’s commonplace today to see women in trousers, this only became popular from the 70’s. There are many reasons for the growth of athleisure’s popularity, but we would highlight three; the trend towards more healthy and active lifestyles for consumers, growth in the digital economy and new media (where this attire is not only acceptable but also encouraged), and a closer association between sporting superstars and their sponsoring brands. Because of this, we expect to see continued sector growth for many years to come.

Just growing with the market is not good enough for Adidas though. It has put in place several initiatives, such as the focus on key cities and the partnership with Kanye West, to help it to gain market share.

#MAGA (Make Adidas Great Again)
Herbert Hainer, Adidas’ former CEO, may have been pushed out following a disappointing year in 2014 that saw the shares fall nearly 40%, but the subsequent “Creating the New” strategy that he implemented in 2015 paved the way for the current success. New CEO Kasper Rorsted has built on this foundation and accelerated its execution, and the results have given the company enough confidence to significantly revise upwards it’s sales and earnings guidance out to 2020.

Since we first invested, the shares have gone up more than fourfold but we still see significant upside from here. Adidas has said many times in the past that the only reason it has a lower operating margin than Nike is due to not having the latter’s scale in North America (Nike is four times the size of Adidas there). As it catches up, the margin uplift will have a dramatic impact on earnings that we think will propel the share price even higher. Like any quality purchase, price is what you pay but value is what you get.

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