Monday, January 1, 2018

Adidas, Nike and Under Armour: The War for Your Workout


What did you wear for your last workout? (Recuse yourself if you are a couch potato)

The three leading international brands of sports and athletic wear, Adidas, Nike and Under Armour (UA) are in a pitched battle for market share (and profit). They always were, but lately it has become more newsworthy because of the growth of Adidas (>20% growth YOY in the last seven quarters), and the precipitous fall of Under Armour’s stock (-46% in 2017).

Lately, Adidas has become very aggressive with TV advertising in their “Calling All Creators” campaign, featuring super-famous athletes like Von Miller, Karlie Kloss, Carlos Correa, Aaron Rodgers, Lionel Messi and many more. These great athletes and other illuminati seriously discuss their solemn responsibility to create, with closeup and pan on their faces, interrupted only by surreptitious camera shots under the table on their (of course!) shiny new Adidas footwear.

So what have we here? The suggestion that, if you too wear the same shiny new footwear, you may be qualified to be a creator (or a superstar athlete?). This is the stuff of dreams-what has built the sports athletic wear industry since the days of Michael Jordan. The endorser, and the subsequent dreams, much more than the product itself—is the MOAT.

So who will win Battle Workout? Who is your money on? Not as in wager, but as in whose sustainable value creation will induce you to invest. To answer that question, our analysis should follow three trains of thought (in some stream of consciousness):

1.     Merchandising/Marketing
2.     Financials/Stock Price/Value Creation for shareholders.
3.     The MOAT

Let’s look back at the commercial (http://www.adweek.com/creativity/adidas-brings-superstar-athletes-like-lionel-messi-and-aaron-rodgers-together-for-a-feast-in-its-latest-spot/), which is a last-supperish scene where all our revered athletes and musicians speak about what unites them-effectively, the commercial gives a subliminal suggestion that what REALLY unites them is their shoes- not the specific shoe, but the brand-ADIDAS.

What has been the most important MOAT for these companies for years is their star power, not their product. Minus a few innovations over three decades like Dri-Fit and Gel, the product ranges from so-so to remarkably ugly (to me the Jordan basketball shoes, which unashamedly reached out to a certain ethnic and social group, were in embarrassing poor taste). More recently, the UA Curry shoes are unremarkable at best.  (I wear ASICS mainly due to function).
Neither Nike nor Adidas can hang their hat on performance as a barrier to entry. On the other hand, Under Armour got its start from an innovation in FUNCTION, and it grew because it was what the athletes actually WORE on the field, and its merchandising emphasized fabric and function over fashion.  Adidas was just sportswear (still is) and Nike never was credible as a function guru.

So what happened to Under Armour? Reports now point to Kevin Plank’s “lack of focus.” I don’t know Kevin, but I don’t buy that. A man who builds a brilliant and distinguished brand since 1996 doesn’t turn stupid overnight. That being said, companies who are very successful and reach the pinnacle of their industry have a tendency to build a bubble of denial and lose their way.

I believe what happened to Under Armour is they failed to see the huge athleisure trend coming, led and maybe started by Lululemon. As the most function-oriented of the three, athleisure would penetrate their MOAT most severely (Nike and Adidas can easily live in the athleisure space, even if they aren’t specifically targeting it).  Current market capitalization finds Lululemon with $8.78 billion, and UA at $5.23 billion. (https://seekingalpha.com/article/4125069-adidas-continues-impress)

For all three, the athleisure trend lowers their barriers to entry and seriously damages their MOAT.  There is nothing remarkable about Nike or Adidas sewing or fabrics (actually, in some ways I would say they are subpar), that distinguishes them from any new entrant to the business. In fact, new entrants would benefit by a fresh look or just a fresh face in the market. But, no special sewing or fabric techniques are required; basically, athleisure wear is just synthetic sportswear with stretch and elastic.

Only Under Armour, of the three, has serious creds in the world of performance (the logo itself came to stand for a higher level of fabric, fit and function).  So it has a MOAT that the other two do not have. IF I were Plank, I would stop working on workout apps (you will not compete with Fitbit and Apple, and the market is very small at best), and go back to my core values=performance. Despite the trend, there is still a loyal customer (me) for functional and handsome workout wear. Currently (see below), IF you can wear the same workout outfit for workout and shopping, it ain’t workout wear. Period. I don’t care what Lululemon tells you. For UA, whatever part of the market that performance wear commands, it is theirs to dominate and their best MOAT.

Speaking of Lululemon, if I were UA and Nike (to a lesser extent), I would stop going after each other and target the queen (?) of the athleisure market. Imagine the UA logo on a garment that looks great, is really functional for workout, and can be worn to Whole Foods with pride? That would be a triumph, but not something that any Tom, Dick or Lulu could duplicate. Not impossible. And the MOAT gets bigger. Bigger Moat=Sustainable Value Creation.

So who wins Battle Workout? Or, rather, who LOSES? That because, as I see it, there can be two winners:
1.     Adidas, because it was solidly into the world of athleisure before it became a word, and because their marketing and advertising plays best into the stars-in-my-eyes moat right now-despite not having a Jordan or a Curry.  As reported by Seeking Alpha,
It was also recently announced that Adidas has passed Jordan brand in terms of market share and is now the second most popular sportswear brand in the United States, next to Nike (note that Nike owns Jordan Brand). This is an important milestone for Adidas, which just a few years was a distant fourth behind Nike, Jordan Brand, and Skechers (NYSE: SKX). (https://seekingalpha.com/article/4125069-adidas-continues-impress)
2.     Under Armour, IF it gets its performance mojo back PLUS uses the resources currently being used for mobile apps to create an offering to top the athleisure world with unassailable function that cannot be easily copied. UA has a history in fabric/function research. It can do it.
3.     Nike is odd man out, in my scenario. The whole brand, to me and to investors, has gone flat. As has the stock.

Quick look at the financial highlights (you can read endless reportage on Seeking Alpha and other investment sites), and then the final BUY or DON’T Buy decision.

1.     Adidas: Adidas (OTCQX: ADDYY) reported impressive third quarter earnings last week. Revenues were up 12% year/year on a currency neutral basis, and EPS also increased by 30% as the company continues to enjoy significant operating leverage. Sales in North America and China grew by 23% and 28% for the quarter, respectively. (https://seekingalpha.com/article/4125069-adidas-continues-impress)
a.     IF Adidas can become a bigger and bigger factor in the athleisure business, it will have a positive effect on both sales and margins in the short term.
b.     It will NOT strengthen its MOAT playing in the athleisure ballpark.
2.     Nike: The stock is currently trading at $62.55, and the overriding opinion is that it belongs somewhere around $50, because:
a.    

How ugly are these blue things?
b.     Underwhelming revenue growth
c.      Sliding Margins
d.     Out-of-Control SG&A (Selling, General and Administrative) Expense- up 10% in Q2 (that’s a lot of money)
e.     Net Income down 9%, despite the fact that Nike’s effective tax rate already down by half. Therefore the positive impact of Trump tax cut already neutralized.
f.      Price at 27x earnings and EPS expected to drop 7% this year
3.    Under Armour-
a.     Buy Low, Sell High, right? IF UA refocus on what its core strengths and opportunities are, it is a bargain right now. To wit: 1 year ago, the stock closed at nearly $30. Now it is around $15. DJIA increased more than 20% in 2017. So UA is 70% or so against the grain.
b.     What happened?
·       Oct. 31, 2017, the company shares fell by more than 15 percent after its third-quarter revenue was below expectations and its full-year sales and earnings per share forecasts were slashed because of operational challenges and lower demand in North America;
·       Jan. 31, 2017, a decline of 23 percent of Under Armour's share prices after the announcement of the stepping down of the CFO; and
·       Oct. 25, 2016, Under Armour's shares were down by 12.7 percent for ("A" shares) and 13.8 percent for ("C" shares), a fall of more than 60 percent since March 16, 2016, after a release of its third-quarter financial report. (https://seekingalpha.com/article/4133815-analysis-armour)
4.     Analyst and I agree about UA mojo:
The success of Under Armour hinges on multiple critical success factors. Perhaps most critical to its success is the status, image, and identity of the brand, and the ability of the brand to compete and win market share in a highly competitive industry. The company is known for technologically advanced athletic wear that is catered to athletes of all kinds for all conditions. Under Armour must maintain and improve its image as technologically advanced athletic wear in the minds of consumers to maintain customer loyalty and win over new consumers. Each and every product it produces is stamped with their iconic logo in order to increase brand awareness and spread its image. Under Armour has done well to maintain its brand through strategic advertising, sports sponsorships, and most importantly, heavy investment in product innovation. (https://seekingalpha.com/article/4133815-analysis-armour)

5.     Red Flags;
Management effectiveness:
Return on Assets = Net income/average total assets = $256,979 / $3,644,331 = 7.1%
Benchmark: 8% to 12% Red flag? Yes
Quality of Earnings:
2016: Quality of earnings = Operating cash flows/net income = $304,487/ $256,979 = 1.18
2015: Quality of earnings = Operating cash flows/net income = -$44,104/ $232,573 = -1.90
2014: Quality of earnings = Operating cash flows/net income = $219,033/ $208,042 = 1.05
Benchmark: > = 2 Red flag? Yes
So, with UA, it all comes down to whether you believe management will recognize their MOAT and focus on core competencies, or will be dragged further into folly such as fitness watches and $200million to Jordan Spieth (love the guy, love golf, but not worth to put a logo on a uniform, and he is no Tiger Woods-just saying).
If, in the best case, management gets its shit together, UA is the only one of the three with a MOAT that cannot be breached by anyone with a few bucks and some crowdfunding.
So, my recommendation:
1.     Adidas- Buy,take a long position
2.     Nike- Sell and Short
3.     UA- Buy common shares and strike price options. Buy more once it is clear their merchandising and marketing is spot on and they are fortifying their MOAT.
Full disclosure: I don’t own any of these and no plans to buy now (I will watch UA, though). There are better ways to invest now.
Fuller disclosure: IF my focus recently has appeared to bend toward the finance/investing side, it has. There is nothing more important to either potential investors or employees than the financial fundamentals that determine if it will grow, or even survive. But, what is even more important are the merchandising and marketing decisions that underlie and cause the fundamentals to be what they are. So why you should read my articles is because I can offer deeper experience and insight into those areas. Most important, we as financial or marketing/merchandising analysts should focus on the MOAT, as it is the key determinant of-everything.









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