It's not often that a sportswear brand opens New York Fashion Week. But that's just what Adidas did with its collaboration with Kanye West -- and with huge publicity to boot. And it looks like the hype is paying off. Adidas said on Thursday that it expects sales to increase 10-12 percent this year, excluding currency movements. It expects a similar rise in net income. Of course, it's not just Kanye that is helping Adidas with his Yeezy tie-up (although that's certainly what the rapper would like us to believe).
Adidas has sharply increased its advertising budget and a generation of "fitsters" are taking sportswear out of the gym and onto the street, while the European Football Championships later this year should give sales an extra kick. Investors certainly believe Adidas has turned a corner. The shares are up more than 12 percent in 2016, compared with a 5 percent decline in Germany's Dax Index.
After the escalation, Adidas trades on 24 times the next 12 months' earnings, compared with Nike's 26 times. Previously, Adidas traded at a much bigger discount to its powerful U.S. rival.
But using rap stars to create buzz doesn't come cheap. The German company lifted its marketing spend -- including in-store promotions -- by 31 percent in the final quarter of 2015. For the full year, higher marketing spending pushed up other operating expenses as a percentage of sales from 42.7 percent to 43.1 percent. Promotional spend will stay about the same level this year, while Adidas hopes to trim costs in other areas.
Adidas also faces higher sourcing costs from Asia, as the dollar has strengthened. Most retailers pay for the goods they buy from Asian manufacturers in dollars. Incoming CEO Kasper Rorsted should be the man to tackle these spending pressures, having closed factories and slashed expenses at Henkel, the maker of Dial soap and Schwarzkopf shampoo.
Despite the recent recovery in the share price, the Adidas adjusted operating margin is still hovering at about 6 percent, so there's plenty to work with. By contrast, Nike's operating margin was about 14 percent over the 12 months to the end of November, according to Bloomberg data.
Cost isn't the only question confronting Rorsted. Gadfly has argued previously that Adidas should play up its fashion credentials by operating more like a fast-fashion brand. This means having more best-sellers in stores and cutting back quickly (within weeks if necessary) on what isn't working. That would help it do fewer discounts and improve profit, though Rorsted probably has less expertise in this area.
He also still has to tackle the poorly performing assets in Adidas's portfolio, TaylorMade Golf and Reebok. The company's already reviewing TaylorMade's future and will announce conclusions shortly. Rorsted must decide what to do with Reebok. While sales rose 16 percent at Adidas in the final quarter, Reebok grew at just 5 percent. TaylorMade's sales declined by a double-digit percentage.
The plan to give board seats to two of its biggest shareholders -- Egypt's richest man Nassef Sawiris and Albert Frere's Groupe Bruxelles Lambert -- makes change more likely. They were the two largest investors in Lafarge before it merged with Holcim to create the world's biggest cement maker.
This all bodes well for the German shoemaker, explaining some of the excitement around the stock. But is still has lots to do to revitalize is supply chain and shake up its asset portfolio. Nike's strong lead on margins makes Adidas's narrowing of the valuation gap look like style over substance.
To contact the author of this story: Andrea Felsted in London at email@example.com