Adidas Group boasts robust underlying performance

The Adidas Group is eagerly turning the page on a year of ups and downs, when ample gains for the Adidas brand were marred by shrinking sales in its golf business and the weakness of the Russian ruble. A few weeks ago the group had already revealed headline figures for last year, indicating that it had reached its revised targets.

Herbert Hainer, chief executive of the Adidas group, appeared almost relieved in a conference call last week to give the full figures for last year and to begin announcing investments for the coming years. They will be detailed at an investor and media meeting in Herzogenaurach at the end of the month.

Hainer emphasized that the underlying sales and profit performance last year was robust. Despite much grumbling by investors about the company's issues last year, it achieved a sales increase of 2.3 percent to €14,534 million for the year, which was a rise of 6 percent in constant currencies.

The group's core asset, the Adidas brand, delivered a sales increase of 6.5 percent to €11,774 million, which amounted to a rise of 10.8 percent in constant currencies. The World Cup held in Brazil whipped up sales of football products by more than 20 percent to €2.1 billion, while the Boost technology supported double-digit sales growth in running.

Adidas Originals' sales rebounded in the second half, spurred by partnerships with Rita Ora and Pharell Williams. The Stan Smith has sold more than 40 million pairs since its launch after a revival last year. The Superstar is in focus this year, which has started strongly for Originals with the Kanye West shoe. Adidas Neo alone reached sales in the range of €800 million after an increase of 27 percent in constant currencies last year.

Sales of the Reebok brand were off by 1.3 percent to €1,578 million last year, although they advanced by 4.7 percent in constant currencies. The company was most satisfied with the Reebok brand's resonance in fitness and sales in its own stores.

The Reebok brand ended the year badly in North America due to a sharp fall in sales of Classics, but Hainer was more upbeat about the potential this year. He referred to the retail launch a few days later of the ZPump Fusion shoe, based on Reebok's famous Pump technology but with an entirely new shoe design. The “Be More Human” campaign is meant to widen the brand's global appeal this year.

The sales rise achieved by Adidas was mostly spoiled by a sales decline of 28.9 percent to €913 million for TaylorMade Adidas Golf (TMAG). The golf company's sales were off by 27.7 percent in constant currencies. The group admitted some failures in this market, particularly the pace of product launches in previous years, while consumers had already stocked up on TMAG equipment. Clean-up efforts, cost-cutting and upcoming new products should enable TMAG to deliver double-digit sales expansion and profit growth in a cleaner and more stable market this year.

While the group's wholesale turnover advanced by 6.0 percent in constant currencies, its retail sales inflated by 11.5 percent to €3,842 million. They were up by 20.9 percent without exchange rate changes. Hainer said the group generated more than half of its sales through controlled space (meaning own and franchised stores as well as shop in shops) and that should continue to increase this year. Online sales have been thriving and are predicted to surpass €500 million this year.

Chiefly due to tumbling sales at TMAG, North America was the only region where the group's underlying sales were on the slide, down by 6.3 percent in constant currencies, as detailed in the table in the next page. The company intends to address that (yet again) with more athlete endorsements and other investments in basketball as well as American football and baseball. Aided by the recruitment of American managers and designers last year, Hainer predicted that the company would return to growth in North America this year.

The group struck back in Western Europe with a sales increase of 8.3 percent in constant currencies, driven by vigorous increases in the German, French and British markets. The company made it clear earlier this year that it would increase focus and investments on these markets, where it was under growing pressure from Nike's advances. The group said the effort enabled Adidas to regain some market share in Europe. The rebound was led by double-digit sales increases in football and running as well as Neo.

Sales in European emerging markets jumped by 19.1 percent in constant currencies. The group enjoyed sales gains of nearly 20 percent in Russia, with increases of 17 percent for Adidas and 24 percent for Reebok, but these increases were wiped out by the crashing ruble.

Adidas reduced its Russian retail investments, opening about 40 stores for the year. It cut its costs and tightly managed inventories. The Russian subsidiary achieved a margin above the group average for the year, in spite of the many discounts offered in the Russian fashion and sports markets. The group is expanding its retail space again this year, starting with stores in Moscow.

Greater China and Latin America both delivered ample sales gains, with buoyant sales in Argentina, Mexico and Brazil. The weaker underlying increase of 1.5 percent in Other Asian markets was blamed on weak sales in the Japanese and South Korean golf markets. Sales were up by 8 percent for Adidas and by 11 percent for Reebok in constant currencies for the region.

Exchange rate changes badly hurt the company. They had an impact of about €550 million on its sales and hit the gross margin, along with growing input costs, clearance activities in Russia and the golf market. The group's gross margin for the year was down by 1.7 percentage point to 47.6 percent.

The group's underlying operating profit from continuing operations was down by 22 percent to €961 million for the full year, amounting to an operating margin of 6.6 percent. However, Hainer emphasized that exchange rate changes shaved about €170 million off this profit and the issues at TMAG caused a deviation of another €200 million. This means incidental factors accounted for an impact of €370 million last year – more than the reported decline of €220 million in operating profit.

All of this is before goodwill impairment losses amounting to a pre-tax charge of €78 million for the year. The loss relates to the crashing Russian ruble and its impact on the retail cash-generating Russia/CIS unit. The group's net income was further affected by a loss of €68 million relating to Rockport, which it has agreed to sell and has been treated in this report as a discontinued operation. Without that and the impairment losses, net income from continuing operations would have dropped by 22 percent to €642 million. But with these two factors on board, the group's net income attributable to shareholders shrank by 38 percent to €490 million for the year.

As previously reported, the group has taken a spate of measures to have a greater impact in the market and to deal with its woes in North America, among other things. The functions of more than 1,500 people have been adjusted in the second half of last year, chiefly to give the category business units direct influence over all aspects of their marketing.

Hainer predicted that the group's sales would increase at a mid-single-digit rate in constant currencies this year, with a significant uptick for TMAG and robust advances for Adidas and Reebok. Currency exchange rates should actually inflate sales, after recent increases in exchange rates for the U.S. dollar and the Chinese renminbi against the euro.

Gross margin should reach between 47.5 percent and 48.5 percent this year. Fewer discounts in golf and more favorable pricing for Adidas and Reebok should support the margin, but on the negative side it should be affected by currency exchange rates in emerging markets, not least Russia.

These same currency changes should significantly impact the group's operating profit margin. It predicted a level of between 6.5 and 7.0 percent for the year, in the same bandwidth as last year's margin without impairment losses. Net income from continuing operations should thus increase at a rate of 7 to 10 percent – compared with the profit of €642 million excluding goodwill impairment in 2014.

The company suggested a dividend of €1.50, a pay-out ratio of 53.9 percent that is way above its habitual range of 20 to 40 percent. Adidas attributed this generosity to the strength of its balance sheet and its confidence in the company's long-term aspirations.

At the same time, the company announced that it was starting with the second tranche of its share buyback program. Treasury shares with an aggregate acquisition cost of up to €300 million but no more than 6 million shares will be repurchased through the stock exchange until July 3 at the latest, with two suspension periods in relation with the shareholders' meeting. The repurchased shares will be cancelled or may be used to meet obligations for the potential conversion of the company's €500 million convertible bond due on 14 June, 2019.

As reported in our previous issue, a search has been started to replace Hainer as chief executive. He declined to confirm if he will remain at the helm until the end of his contract, but pointed out that so far he had stuck to all his contracts. He added that he would not join any other company after his departure.