adidas (OTCQX:ADDYY) (OTCQX:ADDDF) has been severely hit by the pandemic, as its sales have declined by double-digit percentages in the first half of the year. Nevertheless, the company’s stock has rebounded from its 52-week low in March, and it currently trades close to its all-time high. The good thing is that most of its stores have been reopened across the globe, and with the help of the German government, which provided adidas with additional liquidity, the company will be able to weather the pandemic well. As adidas expects to make €600 million to €700 million in operating profit in Q3, there’s no reason not to be bullish about its long-term prospects. Despite trading so high right now, I believe that the stock will continue to appreciate in the upcoming months, and for that reason, I’ve decided to open a long position in the company.
Focus on the long term
adidas has been in the business of selling footwear and apparel for more than 70 years, and in the last few years, its stock has appreciated by triple-digit percentages, as we’ve experienced the greatest economic boom in history. However, at the beginning of the pandemic, the company’s stock tumbled, as adidas’ operations were disrupted by the virus, and it was forced to close the majority of its stores around the globe. Only in May, adidas started to reopen its stores, and at the end of June, 83% of its offline channels were operational once again.
In Q2, adidas’ total revenues were down 35% Y/Y to €3.58 billion. The major decline came from LATAM and emerging markets, as sales there were down 64% Y/Y and 60% Y/Y, respectively. At the same time, the APAC region was not hit as hard as other markets, since the sales there declined by only 16% Y/Y, while the sales in China were flat year over year. As a result, adidas posted a Q2 net loss of €306 million, against a net profit of €462 million a year ago. The good news is that the company was able to offset some of the losses by promoting its products online. From April to June, its digital sales increased by 93% Y/Y and accounted for one-third of the overall revenues during the quarter.
The good thing is that adidas is able to keep its high margins even in the current environment. At the end of June, its gross margin was 51%. In addition, the company has a solid liquidity position to weather the pandemic. Earlier this year, adidas received a loan from the German KfW fund and managed to cut its expenses, which helped it to boost its cash position to €2.02 billion at the end of Q2, which is an increase from €1.98 billion at the end of Q1. While adidas has a net debt position of €792 million, the company’s debt situation is manageable, since most of its debt matures in a few years. In addition, with an investment-grade rating, insolvency risks are non-existent at this stage.
The problem is that it will take time for adidas to improve its bottom line. In the past, the company massively profited from events such as the FIFA World Cup and the Olympic Games. Since the Olympic Games and UEFA Euro Championship were pushed to 2021, adidas will lose a chunk of potential profits this year. In addition, only recently major sports leagues in Europe started to reopen, and this will also have a negative short-term effect on the company’s financials.
Despite all of this, adidas has enough competitive advantages to survive the current economic and health crisis. In addition, despite the fact that the company’s stores are forced to keep the social distancing policy, operate at limited capacity, and at reduced hours, adidas is now able to increase its conversion rate. The company has experienced a bump in conversions in recent months, as customers that visit its stores have a clear intention to purchase adidas’ products.
Going forward, adidas plans to improve its cash inflow by expanding its presence and establishing a stronger foothold in China, where the situation with COVID-19 is under control. In addition, adidas will continue to increase its eCommerce presence, since digital channels have shown a strong performance during the initial months of the pandemic and have all the chances to keep their momentum until the end of the year. Also, the expected growth of the global GDP in 2021 and beyond along with the Olympic Games in 2021 will help adidas to improve its top line.
Another good thing is that the company has already opened more than 90% of its stores across the globe, and it expects its revenues from July to September to grow at a Q/Q basis. In addition, Q3 sales will decline only at a single-digit percentage, which means that the company has all the chances to return to growth in Q4. By being on track to achieve €600 million to € 700 million in operating profit in Q3, I believe that adidas is a solid long-term investment, and the risk of owning its shares is minimal. By trading at an EV/Revenue, EV/EBITDA, and forward P/E multiples that are below the industry’s median, it’s safe to say that adidas stock is relatively undervalued to its peers, and it has more room for growth. Considering this, I’m bullish on adidas’ future.
Source: Yahoo Finance. The table was created by the author
Disclosure: I am/we are long ADDYY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.