We plan to raise our current fair value estimate materially to account for faster sales growth, gross margin expansion, and better controlled expenses.
By Jaime M. Katz, CFA | 03-08-17 | 10:01 AM | Email Article

Narrow-moat  Adidas  closed on another strong year in 2016, with currency neutral revenue rising 18%, as merchandise has been spot on across major categories and regions. The firm benefited from strength in the Adidas brand (up 22%) but also sport performance, originals, and neo, which generated double-digit improvement. Core regions, including Western Europe, North America, and Greater China all experienced growth above 20%.

Jaime Katz, CFA, is a senior equity analyst for Morningstar.

We plan to raise our $96 fair value estimate materially to account for three factors and still view shares as overvalued. First, faster sales growth in 2017, which we had forecast around 9%, is expected to be closer to 11%-13%. Given the fashion momentum the company has at this time, we plan to take our growth up but still anticipate moderating growth trends as the current fashion cycle winds down. Second, gross margin expansion of 50 basis points to 49.1% is better than the 48.3% we had modeled for 2017. If Adidas continues to drive pricing improvement ahead, this sets the forward trajectory for gross margins higher than we previously thought, adding roughly $10 to our fair value estimate. Third, better controlled SG&A expenses ahead adds a few dollars to our fair value estimate. This leads the company closer to its 8.3%-8.5% operating margins in 2017, above our last forecast for under 8%. However, we still view shares as rich, given that the long-term growth rate of sporting good demand is likely to normalize below the top-line growth Adidas is currently capturing.

Longer term (through 2020), Adidas anticipates currency neutral revenue to rise between 10%-12% on average, ahead of our prior forecast; taking our sales estimates to the low end of the range and including a year of economic slowness would add another $5 to our fair value estimate. The Creating the New strategy, highlighting speed, cities, and open source are supporting factors of the growth ahead, attempting to increase brand relevance and thus leverage costs on higher sales.

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Jaime M. Katz, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.
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