After an outstanding performance in 2008 (see separate article), the Adidas Group warned last week that its sales, gross margin and earnings per share were all bound to drop this year. Both the Adidas and Reebok brands suffered sizeable declines in their order backlogs at the end of last year, but company executives feel that Reebok has some upside in the short and medium term, particularly in Europe where its integration is proceeding at full tilt (see separate article).
The Adidas brand should be worst-affected this year with an expected sales drop in the low- to mid-single-digit range in constant currencies. The Reebok group, which include Rockport and CCM Reebok Hockey, is expected to achieve at least flat sales results for the year, in spite of an ominous drop of 17 percent in orders at the end of last year. TaylorMade-Adidas Golf (TMAG) should lift its sales at a low single-digit rate due to the acquisition of Ashworth last November. Taken all together, the Adidas group expects a low- to mid-single-digit sales dip in constant currencies for the full year.
The group’s gross margin will end the year below the unprecedented level of 48.7 percent reached for 2008, according to the management, which blamed the pressure on larger discounts and higher sourcing costs. The latter should affect the company particularly in the first half of the year, due to higher costs for wages and raw materials. At the same time, operating expenses should increase as a percentage of sales, as the group continues to roll out its own retail space for the Adidas and Reebok brands. The group’s operating margin and earnings per share are therefore projected to fall for the full year.
The company again emphasized that order backlogs were becoming increasingly unreliable to forecast growth, due to the heightened reluctance of retailers to order in advance and the rise in at-once orders. In fact, Adidas’ managers have become so disgruntled about the discrepancy between order backlogs and actual sales that they have decided to no longer report detailed backlog figures.
Still, the order backlogs at the end of last year unequivocally point to the expected slowdown in sales. In constant currencies, the Adidas brand’s orders were down by 5 percent in Europe, with a fall of 4 percent in apparel and 3 percent in footwear. Asia was worst affected, as orders for the region were down by 10 percent in constant currencies. Only North America managed to report a stable order book for Adidas, with a 4 percent rise in footwear orders offsetting a 5 percent slide in apparel orders.
Global orders for the Adidas brand were off by 6 percent in constant currencies, mixing a drop of 6 percent for apparel with a decline of 4 percent for footwear. In euros, the brand’s order backlog was down by 4 percent.
The situation was apparently worse for the Reebok brand, which saw its orders take another hit of 17 percent in constant currencies at the end of last year. The Reebok brand’s orders were off by 15 percent in Europe, but its apparent outlook was even worse in the United States, with a 29 percent decline in orders. Asia brought only little comfort, with a 13 percent drop in orders for Reebok products.
However, managers still expect the Reebok group’s sales to be flat for the year, since it cleared off nearly all outdated Reebok products last year and has started launching the products and concepts that are meant to kick-start the brand. Reebok’s sales will also be inflated by added revenues from the acquisition of its business in Brazil, Paraguay and Argentina, which were not consolidated until the second quarter of last year.
The Adidas group’s managers emphasized that the outlook varied from one country to the next. Some of the largest markets were holding up, such as Germany, but others were getting tougher, particularly China. Sales in that country grew by about 40 percent in 2008 and managers still believed they could reach their sales target of €1 billion for the group by 2010, but they acknowledged issues raised in our last edition about the rising resentment of large-scale Chinese retailers and a slowdown in their expansion. Herbert Hainer, the group’s chief executive, said the company’s Chinese subsidiary was working closely with retailers to solve their inventory problems and to improve their sell-through.
Hainer still saw strong chances that the company would grow in local currencies in Russia and China this year, but he was far less sure than last year. The outlook is somewhat more favorable in Russia, where sales are led by company-owned stores and sell-through is still satisfactory in terms of rubles. The situation is less straightforward in China, where sales performance varies strongly from one retailer to the next.
When it comes to the Adidas brand, the group continues to work in more mature markets by segmenting its offering. The launch of Style Essentials, an affordable range of lifestyle products, strongly added to the rise of the Sport Style division’s sales last year. Targeted partly at shoe retailers, it is expected to reach triple-digit-million sales in the medium term.
Another example is the SLVR fashion range launched in company-owned stores this month, in New York and Paris. There are two outlets for SLVR in Paris, both opened last week: one of them a shop in shop at the Adidas brand center on the Champs-Elysées, and the other a stand-alone store on the Rue des Rosiers.
Partly due to continued store openings, the Adidas group’s operating expenses are not expected to decline significantly this year. The company’s managers stated that store openings across the group would probably slow down this year, but they made it clear that Adidas would not make a point of drastically reducing retail expansion – nor marketing expenses. Last year the company ordered a hiring freeze and a reduction in travel expenses, and earlier this year it confirmed that more than 500 jobs would be shed. However, the group’s managers stated that it was not their intention to launch wider restructuring plans and that the job count should remain stable at group level this year.
Group executives were given strong credit for coming forward with a detailed projection for the full year, and for their frank description of the tough and uncertain months ahead. Hainer half-jokingly summed up the situation by stating that the group had a tight grip on its own business, but everything that was out of its control was indeed out of control – from the economic situation to political decisions and currency fluctuations.
Robin Stalker, the Adidas group’s chief financial officer, was yet more specific on risks and balance sheet issues. There was some concern about inventories, which were up by 21 percent in constant currencies at the end of last year. The company attributed this to the fact that it had pulled forward some production at the end of last year to benefit from more attractive prices. Secondly, inventories were inflated by the consolidation of Reebok’s business in three Latin American countries, and by the acquisition of Ashworth.
These factors accounted for about half of the increase in inventories, but it could not be denied that they were equally affected by slower than expected sales in the fourth quarter – and the cautious attitude of retailers, which meant that Adidas had to hold more inventories to quickly fulfill re-orders.
At the same time, receivables were up by 13 percent in constant currencies last year, as retailers in several countries were dragging their feet for payments. The problem worsened toward the end of the year and the Adidas group is now monitoring the situation on an almost daily basis.
Another issue to be addressed this year is an increase of 24 percent in the Adidas group’s net borrowings last year, which reached almost €2.2 billion. Net cash generated by operating activities amounted to nearly €500 million last year, but this was lower than in 2007. Other factors affecting the group’s debt position included a share buyback of €409 million, the acquisitions sealed in 2008 and negative currency effects.
While the company’s balance sheet remains healthy, Stalker is making it a priority this year to pay down debt. The Adidas group’s financial leverage at the end of last year reached 64.6 percent, but the company has set itself a medium-term target of below 50 percent. One of the consequences is that the group will not go ahead with any further share buybacks for the time being.
Stalker pointed to currency risks as one of the significant issues facing the Adidas group this year. It has hedged nearly all of its U.S. dollar needs for 2009, but is more concerned about other currencies such as the ruble, which are much harder – or at least much more expensive – to hedge.
