Adidas Sees Strong Sales, Margin Pressure in 2016

Adidas Sees Strong Sales, Margin Pressure in 2016

Adidas warned investors that rising labor and raw-material costs could weigh on profitability over the next four years during a meeting in Germany.

Adidas predicted stable operating margins in 2016, with higher production costs and the strength of the dollar being offset by increased supply-chain efficiency, price increases and cost savings, higher input costs and unfavorable foreign exchange effects.

In a statement, the company said as the company sources the vast majority of its products from more than 30 countries around the world, sourcing costs are constantly impacted by both global and local macroeconomic trends.

“Ongoing double-digit increases in labor costs in most emerging markets and higher material costs for cotton, nylon and EVA are currently putting upward pressure on future product costs,” Adidas wrote. “As a result, the Group expects a significant increase in its underlying sourcing expenses by 2020. To counterbalance this headwind, the company will continue to work on further increasing its production efficiencies by focusing on four levers: product and materials, supply base and allocation, level loading as well as productivity improvements.”

As a globally operating company, the Adidas Group also said it is exposed to exchange rate fluctuations. This is a direct result of the Group’s Asian-dominated sourcing activities, which are largely denominated in U.S. dollars, while sales are denominated in other currencies to a large extent. As a consequence, hedging U.S. dollars is an important part of the company’s centralized currency management. The Group has established a hedging system on a rolling basis up to 24 months in advance, under which the vast majority of the anticipated seasonal purchasing volume is hedged approximately six months prior to the start of a season. As a result, the company has almost completed its anticipated hedging needs for 2016, expecting Group gross margin to be negatively affected by the unfavorable effects from a stronger US dollar against most major currencies.

In total, higher input costs and unfavorable foreign exchange effects are expected to significantly weigh on the Group’s gross margin development in 2016. However, the company expects to be able to compensate the vast majority of those negative effects, thus limiting the projected gross margin reduction to between 50 and 100 basis points compared to the 2015 level. In addition to supply chain efficiencies, this will be achieved by significant price increases in several regions, adjusted trade terms with the company’s retail partners, over-proportionate growth in higher-margin markets as well as a more favorable category, product and channel mix.

At the same time, the Group expects to benefit from the consequent execution of operational improvements achieved throughout the last few years and from leveraging its brand leadership re-organization to become more consumer-centric which will improve the company’s decision-making processes. In addition, the Group will continue to optimize the overall organizational set-up and focus on initiatives that drive further efficiency gains. As a result of these initiatives, management expects to continue to generate substantial operating overhead leverage in 2016.

Simultaneously, the Group said it remains committed to its long-term marketing investment strategy aimed at sustainably increasing brand desirability and accelerating top-line growth over the next five years. For 2015 and 2016, the company therefore increased its marketing spend target range by one percentage point to a level of between 13 percent and 14 percent of sales from the previous corridor of 12 percent to 13 percent of sales. As a result, sales and marketing investments are expected to further increase in absolute terms next year and, as a percentage of sales, remain at around the 2015 level.

Taking the expectations for both sales and marketing investments as well as operating overhead expenditures into account, the company projects a significant reduction of its operating expenses as a percentage of sales, which will at least compensate the projected gross margin decline. As a consequence, the Group’s operating margin is expected to at least remain stable in 2016 compared to the 2015 level. In absolute terms, the Group’s operating profit is forecasted to improve at a high-single-digit rate next year.

Robin Stalker, Adidas Group CFO, said in a statement, “We are well-prepared to cope with the cost pressure that the entire industry will be facing next year. On the one hand, our brands and products are enjoying strong momentum. On the other hand, we are optimizing our processes throughout the Group and along the entire supply chain to drive further efficiency gains and we are continuing our structured hedging approach. We therefore have all the levers in our hand that will enable us to stay on our growth path in 2016 – and beyond.”

The warning on the expense issues came while Adidas officials expressed strong confidence that its recent momentum will continue. Adidas CEO Herbert Hainer particularly highlighted his enthusiasm in a continued rebound in the North America region, predicting sales would increase by a double-digit percentage point next year.

“I have never seen the order books as full in my 15 years here,” Hainer said at a news conference at the company’s headquarters in Bavaria. “I am extremely optimistic as I know what we’ve sold for the first six months (of 2016).”

To turnaround the business, Adidas has made several management changes, increased its marketing push, and shifted to a more-Americanized focus at the company’s U.S. business. In early November, the company raised its outlook for 2015 and posted a 10 percent profit rise in the third quarter.

“We have changed a lot,” he reportedly said at the conference. “I am happy and proud…I do not in any way worry about the future.”

He noted that the North America business has benefited from a hike in marketing spending in the region by 50 percent in the first nine months of the year, as well as the addition of several new U.S. star athletes and college leagues. Sales of the core Adidas brand are projected to grow by 10 percent or more in North America in 2016, up from 8 percent in the first nine months of 2015, he said. Next summer’s Olympic Games in Brazil and European soccer championship in France are projected to help spur global demand for the Adidas brand, he said. Sales of global football are expected to rise at a double-digit rate next year.

Growth at its performance business is expected to be “particularly strong,” largely due to the introduction of new price ranges, he said. The company’s urban lifestyle brands, Adidas Originals and NEO, are also projected to contribute to growth in 2016.

Hainer, 61, also indicated he plans to stay until the end of his contract in March 2017 even though the board is seeking a successor. Adidas also that indicated that although significant increases in sourcing costs are expected to pressure earnings in coming years, a “record” year is expected for 2016.

Hainer has been in his job since 2001 and represents the longest-serving boss of a German blue-chip firm. Last year, Adidas’ board extended his contract to 2017. In February, however, the board said it had launched a search for a successor.

Last year Hainer, 61, faced calls to step down from some major investors after Adidas lowered its guidance several times and eventually missed its five-year growth goals for 2015. Falling golf sales in its TaylorMade-Adidas Golf segment and its exposure to Russia has particularly challenged the company. But what’s been noticeable to investors has been Adidas’ loss of market share to Nike globally and the Adidas brand’s slide to the third largest athletic brand in the U.S. after Under Armour.

The pressure on Hainer has lately abated as Adidas’s shares have rebounded 55 percent this year as earnings and sales have recovered. The stock has become one of the strongest performers in the German DAX index.

“Investors are all satisfied,” Hainer said, noting that he has regularly met with the company’s major investors in the last year. “What all really like is the Adidas brand. It is such a strong brand and it has such sheen. That is what really interests them.”

Reuters reported last week that Egyptian tycoon Nassef Sawiris had formed a partnership with U.S. investor Mason Hawkins of Southeastern Asset Management to drive change at companies, including Adidas. Both groups had owned small stakes in Adidas and Southeastern Asset Management has called for the hiring of an external candidate.

Stressing that he is feeling little pressure to step down, Hainer said the board is taking its time to consider external candidates as well as internal ones.

“Of course I will stay until the end of my contract,” he said, adding he had doubled sales and profit at Adidas in the last decade. “At some point an announcement will come and then we will see how quickly the person can come.”

Hainer also repeated his rejection of calls from some investors for Adidas to sell Reebok, which was acquired in 2006. He said the business was now growing at double-digit rates everywhere except in North America.

Finally, he denied a report in the New York Post that Adidas was preparing to sell its CCM ice hockey equipment business. He said Adidas has heard from interested parties in acquiring CCM but no current sales process is in place.