A few months ago, I wrote down some of my thoughts on these three companies and shared my view that only Nike (NKE) was a compelling medium-long term investment in the group. In this article, I am going to update my view and compare the three companies/stocks again.
When assessing the long-term prospects of a company is necessary to verify whether the company has some kind of competitive advantage that can protect its business against competition and, therefore, give the company the possibility to exploit growth opportunities in its industry without being overwhelmed by the competition. The sportswear industry has a significant (but not excessive) fashion component, so the attractiveness of a brand shows a certain degree of variability over time. Nonetheless, there are certain characteristics that actually limit competition in comparison to the crowded and fragmented apparel market, giving some protection to sportswear brands with a solid following and a good market share. The presence of a “performance” segment used for sports activities is a factor that obviously limits competition, due to the high investments and know-how that is necessary to compete with firms such as Nike and adidas (OTCQX:ADDYY) (OTCQX:ADDDF).
That said, it’s obvious that patents and know-how are not the main competitive advantages that these companies have, and it’s obvious that not all sportswear firms are equal. To understand which company has the strongest competitive position it’s necessary to focus on other competitive leverages that are important in the market. One of the most important factors is brand power. This doesn’t mean simply that the most popular brand is in the best competitive position. We have to focus on the factors that help a brand being popular and if these factors can give a sustainable competitive advantage. At this regard, I think the comparison between Nike, adidas and Under Armour (UAA) (UA) is very interesting. Nike is by far the most popular brand, thanks to its strong leadership in North America, although its popularity is basically equivalent to adidas in the rest of the world. It might sound simplistic, but Nike’s popularity in North America is a strong competitive advantage that I think will continue to protect the company for a long time. The reason is quite simple. While Nike’s main competitor adidas manages to compete effectively in most of the world, its scale disadvantage in North America is the main reason why its margins are so weak compared to Nike’s margins. As we can see in the chart below, the difference is significant.
The main point to assess is whether this gap is something that Nike’s competitors can easily close. Besides the obvious scale advantage that gives Nike the possibility to leverage some fixed costs better than its competitors, there is also a strong lead in terms of marketing spending that has built a good competitive advantage for Nike. Sportswear companies rely on massive sponsorship deals to strengthen their brand power and make their products more attractive. Nike is by far the company that spends the most in sponsorships and endorsements. It has lifetime deals with athletes such as Michael Jordan, Lebron James and Cristiano Ronaldo, and has endorsement deals with a large number of athletes such as Roger Federer, Rafa Nadal, Kevin Durant, Rory McIlroy, Neymar and Maria Sharapova, to name a few.
Adidas is also strong when it comes to sponsorships and endorsements, with a lifetime sponsorship deal with Lionel Messi, and numerous other contracts with famous athletes such as Derrick Rose and Damian Lillard, while Under Armour has important deals with athletes such as Stephen Curry or Tom Brady, to name a few. To make a comparison, in 2016, Nike spent $3,278 million in "demand creation expenses", against about $2,080 million (€1,981) of marketing expenses for adidas, and $477 million for Under Armour. For all the three companies, the total amount spent for marketing is always around 10% of total sales. Nonetheless, Nike has much wider margins, which has an important implication – no competitor has the interest in trying to gain market share through aggressive sponsorships or marketing spending, as an additional dollar spent in marketing expenses by adidas or Under Armour damages their margins more than an additional dollar spent in marketing would damage Nike’s margins. In other words, Nike has a higher efficiency and can bear higher costs compared to its main competitors.
There is also another important factor to consider. Nike’s dominance in North America gives the company a more diversified exposure to sports and consumer segments compared to adidas and Under Armour. Let me explain this point better. While Nike and adidas are basically equal outside the United States and their marketing spending in terms of sponsorships and endorsements is mainly focused on football teams and players, in North America the marketing battle is more diversified across sports, and football athletes/teams are a secondary target for sponsorships and endorsements. The high importance of the basketball shoe category and Nike’s dominance in this field gives the company a strong and durable competitive advantage. This means that adidas’ expansion in the United States will hardly benefit from the expansion in Europe and Latin America, as there is little overlap with the American market.
Recent Developments And Brand Attractiveness
Adidas has managed to grow and gain market share at the expense of Nike in the last few years, thanks to some positive fashion trends that helped sportswear companies with a lifestyle positioning, including adidas and its German competitor Puma (PUMMF). On the other side, Under Armour’s growth in the past few years had a significant fad component that generated a boom and bust pattern in the stock price. As we can see, revenue growth is falling down fast:
In particular, the negative trend is evident in North America, where sales started to contract last quarter:
There is an evident gap in growth rate between adi-armour and Nike, a clear sign that Nike is losing some market share to these competitors. Nonetheless, the gap is narrowing and Nike is the only company in the group to report a slight improvement in revenue growth, while UA is reporting falling growth rates and adidas’ guidance suggests the growth rate will fall to 11%-12% from 18% last quarter. In Q4, Nike’s YoY revenue growth rate rose from 5% in Q3 to 5.3%. Not a huge difference, but still an indication that Nike’s revenue growth is moving in an opposite direction compared to adidas and Under Armour.
In addition to that, it’s very important to track consumers’ interest towards these brands, especially if we want to understand whether adidas and Under Armour will continue to gain market share at the expense of Nike. To do this, it’s useful to track Google Trends data, which show search interest on the web for each of these brands. I calculated the YoY difference in search to neutralize seasonal effects, and I applied an 8-week moving average to smooth the trend and make it easily visible.
As we can see in the chart, the variation for search interest is in negative territory for all the three brands. Nonetheless, Nike is the only brand in the group that is showing a stable trend since the beginning of the year, while Under Armour has stabilized a bit only starting from April and adidas is falling extremely fast. This is the most important piece of information we should focus on. The search interest for adidas was much stronger than the search interest for Nike, but it’s now converging very fast with Nike’s levels. If the current pace continues, the gap in search interest will disappear in less than a quarter. It’s evident that customers are not interested in adidas as they were before, and the sharp decline does suggest the brand benefited from temporary strength, as I indicated a few times.
In my previous articles, I wrote that it was difficult to justify the valuation gap between adi-armour and Nike, especially if the growth rates continued to converge so fast. Although the gap has narrowed a bit, we can still see a significant premium of adi-armour over NKE, despite the falling growth rates of the formers and the stable/slightly improving performance of the latter. In terms of EV/EBITDA, the gap closed a few weeks ago, but P/E multiples still show a wide gap.
Since I expect the growth rates to converge in just a few quarters and the difference in marginality to remain significant, I think the valuation gap based on P/E is excessive. Under Armour and adidas continue to look expensive based on these multiples, and I expect their valuation to fall in the next quarters.
Solid Balance Sheets, Shareholder Friendly Behaviors
The fact that UA and adidas have overpriced stocks has nothing to do with their quality as companies. All the three companies have manageable levels of debt and decent balance sheets, and I will not spend time discussing this topic. I prefer focusing on another aspect. Comparing the companies' policies when it comes to dividends and stock buybacks, we can see how Nike shows the most "shareholder-friendly" behaviors.
Nike pays a $0.68 dividend per share (1.23% yield), against a €2.00 dividend per share for adidas (1.1% yield), while Under Armour pays no dividend. Moreover, Nike has been involved in effective buyback programs that have constantly reduced the number of shares outstanding. Adidas has been less active on that front, while Under Armour’s shareholders have suffered from a constant stock dilution.
Before drawing conclusions, let me share some more thoughts on each of these companies/stocks, starting with Under Armour. Although I see a modest stabilization for Under Armour from this point, I still think the current valuation gap with adidas and Nike is too big. In another article I wrote:
It's obvious that the company's growth was in part a result of a fad, helped by the popularity of its endorser Stephen Curry. Sales growth in North America is declining extremely fast and, at this pace, will soon approach negative territory (see chart below). Under Armour's main problem is that it has to compete with two giants with much higher brand power and financial resources. I've heard (and read) many people compare Under Armour to the Nike of the 1990s and suggest a scenario of resurgence for UA similar to what happened to Nike. I think investors should remain realistic and consider the different contexts. Nike didn't have to face competition from two players that were 4 or 6 times bigger, while it was benefiting from favorable trends that led an increasing number of young people to adopt sportswear as a choice of style. Under Armour has a strong scale disadvantage and is not on the right side of the current fashion trends. I think the company will also find it difficult to gain market share outside the United States, due to the limited reach of its marketing investments. The endorsement of stars such as Tom Brady and Stephen Curry can be useful in North America, but have little to no effect in Europe or Latin America.
In that article, I said the growth rate in North America would soon reach negative territory, something that happened last quarter, and I pointed out how the company’s smaller scale can be a competitive disadvantage. I re-affirm that it doesn’t make any sense to believe that UA can be the next Nike. This belief is silly and based on no rational reason. Nike is the only Nike we will see in the future, and investors should never confuse temporary fashion trends with long-term growth trajectories. Moreover, they should never confuse fad with competitive advantages.
Adidas is a different case, but there are some factors involved that mirror what happened to Under Armour. Fashion trends helped adidas gain market share at the expense of Nike, and there was no competitive advantage that put adidas ahead of the American competitor. Fashion trends come and go and, as we have clearly seen in Google Trends data, all the great interest for adidas is falling almost as fast as it grew. The recent overperformance looks hard to replicate, and the valuation gap is destined to narrow in the next quarters. Despite the favorable effect of what I call the” Kanye West Athleisure Trend” and the strong rise in popularity of the brand in the last 3 years, the main competitive disadvantages against Nike remain – A smaller scale, a weaker position in North America, lower margins.
Nike does look like the best stock to bet on if we want long-term exposure to the industry. It has a scale advantage, an extremely strong competitive position in North America, and it has high margins that guarantee a better flexibility when it comes to “demand creation expenses”. It is also the cheapest in the group, even though at 23 times TTM earnings the stock is not dirt-cheap. On the other side, it’s still trading below the market average P/E multiple of 25.6, and I doubt the average stock in the S&P 500 has the same competitive strengths and growth prospects of Nike.
I confirm all my previous positions, and in particular:
- I am long NKE with a medium-long term horizon. I think it’s the best investment vehicle for taking advantage of the secular growth in sportswear and athletic footwear, thanks to its leading position and exposure to all the emerging economies.
- I am short adidas shares as I think the strength saw in the last 3 years is extremely hard to replicate and I expect the company’s growth rate to converge fast with Nike’s growth rate. I re-iterate my sell rating with an initial €153 price target.
- I am short UAA, because valuation doesn’t reflect rational expectations. The current weakness in North America will hurt revenue growth and margin expansion and will leave an excessive valuation gap with the peer group.
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Disclosure: I am/we are long NKE. 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.
Additional disclosure: I am short UAA, adidas shares.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.