Adidas 16Th January 2013 Athletic Growth; Easy Valuation Luxury & Consumer Goods Fair Value EUR82 Vs

INDEPENDENT RESEARCH UPDATE adidas 16th January 2013 Athletic growth; easy valuation Luxury & Consumer Goods Fair Value EUR82 vs. EUR67 (price EUR68.20) BUY

Bloomberg ADS GY We increase our Fair Value to EUR82 from EUR67 due to a roll-over Reuters ADSG.F to 2013 in our DCF computation and updated modelling criteria. As 12-month High / Low (EUR) 69 / 54 we introduce our 2015 estimates, we re-iterate adidas as the top pick in Market capitalisation (EURm) 14,269 Enterprise Value (BG estimates EURm) 14,045 our coverage given the company’s strong earnings growth (2012-15e Avg. 6m daily volume ('000 shares) 803.1 EPS CAGR of 20%) and attractive valuation, which in our view still Free Float 100% does not reflect adidas’ potential to increase its EBIT margin to 11%. 3y EPS CAGR 20.4% Gearing (12/11) -2% Dividend yield (12/12e) 1.86%  Bullish medium-term top-line prospects. In the past three years (2009-12e), adidas recorded a sales CAGR of 10% FX-neutral. In this YE December 12/11 12/12e 12/13e 12/14e Revenue (EURm) 13,344 14,931 15,740 16,798 context, the consensus expectation of 6% average growth in 2012-15e EBIT (EURm) 1,011 1,186 1,412 1,688 seems achievable. adidas continues to see good growth in its three Basic EPS (EUR) 3.20 3.84 4.69 5.71 priority markets, the US, Russia and China, outpacing competitors. Diluted EPS (EUR) 3.20 3.77 4.60 5.60 EV Sales 1.1x 0.9x 0.9x 0.8x Importantly, following the success of the lightweight concept, adidas EV/EBITDA 11.3x 9.6x 8.0x 6.5x seems to have a strong product pipeline to offset the absence of a major EV/EBIT 14.0x 11.8x 9.6x 7.7x sporting event in 2013. Regarding Reebok, after a poor 2012 impacted by P/E 21.3x 18.1x 14.8x 12.2x ROCE 10.4 11.4 12.9 14.9 licence changes, problems in India and the lack of innovation, we expect

a rebound in 2013 thanks to new product launches. 16/1/13 135 130  Under-appreciated margin expansion potential. We expect adidas to 125 increase its EBIT margin by 100bps every year to reach management’s 120

115 11% target in 2015 (vs. consensus 10.7%) from 7.9%e in 2012. Beyond

110 the easier sourcing environment in 2013, adidas should benefit from 105 growth in higher-margin emerging markets and self-help measures such 100 as SKU reduction, shared services, retail/logistics efficiency and an 95 improvement at Reebok. Looking at average EV/Sales valuation for 90 J F M A M J J A S O N D J ADIDAS (XET) STOXX EUROPE 600 E - PRICE INDEX companies in the Stoxx 600 with c.11% EBIT margin, we argue the Source: Thomson Reuters Datastream market has not factored in adidas’s profitability improvement.

 Attractive valuation. adidas is trading at 12.2x PE14e vs. a 10-year average forward PE average of 12.8x. Given we expect adidas to record a 2012-15e EPS CAGR of 20%, we would not be surprised to see multiples at the higher end of the historic range (16x), seen on a few occasions since 2005.

Analyst: Sector Analyst Team: Peter Farren Nikolaas Faes 33(0) 1 56 68 75 72 Loïc Morvan [email protected] Cédric Rossi

r r

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ROCE (%) Simplified Profit & Loss Account (EURm) 2009 2010 2011 2012e 2013e 2014e 16% Revenues 10,381 11,990 13,344 14,931 15,740 16,798 14% Change (%) -3.9% 15.5% 11.3% 11.9% 5.4% 6.7% 12% Adjusted EBITDA 780 1,159 1,257 1,462 1,708 2,007 EBIT 508 894 1,011 1,186 1,412 1,688 10% Change (%) -52.5% 76.0% 13.1% 17.3% 19.1% 19.6% 8% Financial results (150) (88.0) (84.0) (61.0) (39.8) (16.2) 6% Pre-Tax profits 358 806 927 1,125 1,372 1,672

4% Tax (113) (238) (257) (320) (391) (477) Minority interests 0.0 (1.0) 0.80 0.0 0.0 0.0 2% Net profit 245 567 671 804 981 1,195 0% 2010 2011 2012e 2013e 2014e Restated net profit 245 567 671 804 981 1,195 Change (%) -61.8% 131% 18.3% 19.9% 22.0% 21.9% Cash Flow Statement (EURm) 1,000 FCF (EURm) Operating cash flows 429 798 810 1,080 1,277 1,515 900 Change in working capital 769 96.0 (18.0) (280) (124) (148) 800 Capex, net (215) (251) (374) (433) (456) (487) 700 Financial investments, net 53.0 (79.0) (192) (25.5) 30.2 34.0 600 Dividends (97.0) (73.0) (170) (209) (265) (343)

500 Other (415) (165) (321) 0.0 0.0 0.0

400 Net debt 917 221 (91.0) (224) (685) (1,254)

300 Free Cash flow 983 643 418 367 696 879

200 Balance Sheet (EURm)

100 Tangible fixed assets 723 855 963 1,120 1,280 1,448

0 Intangibles assets 2,980 3,128 3,243 3,243 3,243 3,243 2010 2011 2012e 2013e 2014e Cash & equivalents 775 1,156 906 906 906 1,476 current assets 3,710 4,724 5,529 6,132 6,424 6,791 Other assets 687 755 739 739 739 739 Company description Total assets 8,875 10,618 11,380 12,140 12,592 13,697 adidas Group is the world's second L & ST Debt 1,767 1,610 1,280 1,147 686 686 Others liabilities 3,332 4,385 4,769 5,066 5,263 5,515 largest sporting goods manufacturer Shareholders' funds 3,776 4,623 5,331 5,926 6,642 7,495 behind Nike with brands including Total Liabilities 8,875 10,618 11,380 12,140 12,592 13,697 adidas (77% of group sales), Reebok Capital employed 6,124 6,830 7,248 7,685 7,970 8,286 (11% of group sales), TaylorMade (9% Ratios of group sales), Rockport and CCM Operating margin 4.89 7.46 7.58 7.94 8.97 10.05 (3% of group sales). Tax rate 31.56 29.53 27.76 28.50 28.50 28.50 Net margin 2.36 4.73 5.02 5.39 6.23 7.12 ROE (after tax) 6.49 12.26 12.58 13.57 14.77 15.95 In 2011, adidas Group had a 21% ROCE (after tax) 5.30 9.73 10.38 11.35 12.90 14.85 share of the global athletic footwear Gearing 24.29 4.78 -1.71 -3.77 -10.31 -16.74 market vs. Nike's 36.9%. Pay out ratio 28.03 29.52 31.20 33.00 35.00 40.00 Number of shares, diluted (‘000) 209,238 209,216 209,216 215,206 215,206 215,206

The company was founded in 1949 by Data per Share (EUR) EPS 1.25 2.71 3.20 3.84 4.69 5.71 Adolf Dassler. It is based in Restated EPS 1.22 2.71 3.20 3.77 4.60 5.60 Herzogenaurach in Germany, and has % change -60.3% 122% 18.3% 17.5% 22.1% 21.7% over 46,000 employees worldwide. As EPS bef. GDW 1.22 2.71 3.20 3.77 4.60 5.60 part of its 'Route 2015' business plan, BVPS 18.05 22.10 25.48 27.54 30.87 34.83 Operating cash flows 2.05 3.81 3.87 5.02 5.93 7.04 adidas Group aims to generate FCF 4.70 3.07 2.00 1.71 3.24 4.08 EUR17bn sales and an EBIT margin Net dividend 0.35 0.80 1.00 1.27 1.64 2.29 of 11% by 2015.

The IPO happened in 1995 and the Source: Company Data; Bryan, Garnier & Co ests. share capital is fully free float.

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1. Investment Case

The reason for writing now In this report, we introduce our 2015 estimates, which reflect our view that adidas can beat sales guidance (BGe EUR17.7bn in 2015 vs. guidance of EUR17bn) and can meet the EBIT margin target of 11% (vs. consensus 10.7%). We re-iterate adidas as the top pick in our coverage given the company’s strong growth prospects (2012-15e EPS CAGR of 20%) and attractive valuation.

Valuation We increase our Fair Value to EUR82 from EUR67 as a result of the roll-over to 2013 in our DCF computation, the introduction of our 2015 estimates and new modeling criteria. adidas is trading at 12.2x PE2014e vs. a ten-year average forward multiple of 12.8x: given the company’s prospective growth rate (2012-15e EPS CAGR of 20%), we would not be surprised to see this multiple at the higher end of the historic range at around 16x.

Catalysts Q4 12 results will be published on 7th March. We expect Q4 sales growth to remain at the Q3 level of +4% FX-neutral, confirming the slow-down vs. the +11% of H1 12. We highlight the fact that Q4 should be impacted by the lack of Reebok’s NFL licence (won by Nike this year) and TaylorMade’s product launch calendar. In 2013, we expect growth to pick up, especially after Q1 which has the toughest comparison base in terms of FX-neutral sales growth (Q1 12 +14%; Q2 12 +7%; Q3 12 +4%).

Difference from consensus Our 2015 EBIT margin estimate of 11% is in line with the company’s guidance, but above consensus of 10.7%, suggesting there is still some scepticism as to whether management can achieve its target. We think there is a number of powerful gross margin levers (adidas’ pricing power, easing sourcing environment in 2013, emerging market out-performance, Reebok product mix, SKU reduction), which combined with operating leverage, makes this target achievable. We believe the market is currently not pricing in adidas’s medium-term growth prospects.

Risks to our investment case Beyond a slow-down in consumption, we have identified the main downside risks as Rouble weakening and inventory hang-over. Nonetheless, we think adidas is better positioned now to face those headwinds than it was in 2009.

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2. Valuation

2.1. Our new DCF yields a Fair Value of EUR82 Our fair value of EUR82 (vs. EUR67 previously) is derived from a Discounted Cash Flow computation using the following criteria:

• A WACC of 9.6% based on an equity risk premium of 6.1% (vs. 6.3% previously), a risk-free rate of 3.3% (vs. 3.4% previously) and a beta of 1. • A terminal growth rate of 2% and an operating margin of 11% by 2015.

The Fair Value increase from EUR67 is driven by the roll-over to 2013 in our DCF computation (EUR7), the introduction of 2015 estimates as we factor in an 11% EBIT margin vs. 10.6% previously (EUR5) and the changed parameters for the ERP and risk-free rate (EUR3).

Fig. 1: Explicit estimates

(EURm) 2013e 2014e 2015e 2016e 2017e 2018e 2019e 2020e Sales 15,740 16,798 17,717 18,780 19,531 20,508 21,328 22,181 % growth 5% 7% 5% 6% 4% 5% 4% 4% EBIT 1,412 1,688 1,952 2,066 2,148 2,256 2,346 2,440 EBIT margin 9.0% 10.1% 11.0% 11.0% 11.0% 11.0% 11.0% 11.0%

Source: Bryan, Garnier & Co ests.

Fig. 2: DCF computation

(EURm) 2013e 2014e 2015e 2016e 2017e 2018e 2019e 2020e Cash-flows 725 891 1116 1167 1217 1247 1329 1382 WACC discount factor 1.00 0.91 0.84 0.77 0.70 0.64 0.59 0.54 NPV of cash-flows 725 815 934 894 852 799 779 741 Residual value 20,336 NPV of residual value 10,906 Total present value 17,444 - Net debt (224) = Value of shareholders’ funds 17,668 - Value attributable to minorities 11 = Value to common shareholders 17,657 Number of shares outstanding (m) 215.2 Theoretical value per share (EUR) 82

Source: Bryan, Garnier & Co ests.

2.2. Under-appreciated margin potential Having analysed the valuation of Stoxx 600 companies with profitability similar to adidas’s in 2013 and those with margin levels we expect for adidas in 2015, we conclude adidas’s current valuation does not reflect the company’s margin improvement potential.

Within the Stoxx600 universe, 25 companies are expected to have an EBIT margin in the 8.5-9.5% range in 2013 (vs. adidas’s 9%e). The average EV/Sales 2013 multiple for those stocks weighs in at

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0.77x, not far from adidas’s 0.84x on our estimates. Within this same universe, 18 companies are expected to have an EBIT margin in the 10.5-11.5% range (compared with our estimate of 11% for adidas in 2015). The forward EV/Sales multiple for this sample weighs in at 1.08x.

Therefore, assuming the market is willing to pay a forward EV/Sales multiple of 1.08x for a stock with an 11% EBIT margin, we derive a fair value of EUR98 / share for adidas in 2014 (assuming 2015 sales of EUR17.7bn and net cash of EUR1.88bn. If we discount this at a 9% rate, we calculate a fair value for adidas of EUR90 per share at end-2013. The average forward EV/EBIT multiple for companies with a 10.5-11.5% EBIT margin comes in at 10.1x vs. adidas’s 9.4x. With the same methodology as above, we derive a fair value of EUR100 / share in 2014, and EUR92 when discounted at 9%.

We recognise that this analysis does not take into account the capital intensity of companies, which of course is important with regards to what multiple the market is willing to pay for a given margin, but we nonetheless thought the comparison was noteworthy.

2.3. Multiples below historic averages based on 2014 On our numbers, adidas is trading at 14.8x PE13e and 12.2x PE14e, vs. the 10-year forward P/E average of 12.8x. Given the strong earnings momentum we expect in the medium-term (2012-15e EPS CAGR of 20%), it would not be surprising to see adidas trading at the higher end of its historic range of around 16x, reached a number of times since 2005 as shown on Fig.3. adidas’s net cash position of EUR91m at end-2011 and strong cash flow generation means it is also trading below historic EV/EBITDA multiples (8x EV/EBITDA 2013e and 6.5x EV/EBITDA 2014e on our ests. vs. 7.6x 5-year average). Note that the last data on the graphs below concern 2013 earnings estimates, not 2014.

Fig. 3: Evolution of adidas’s forward P/E multiple (consensus ests.)

7 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

Source: IBES

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Fig. 4: Evolution of adidas’s forward EV/EBITDA multiple (consensus ests.)

4 Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

Source: IBES

2.4. adidas’s discount to Nike does not reflect relative earnings growth On our numbers, adidas is currently trading at an 23% discount to Nike on a P/E 2013e metric (vs. a 5-year average of 22%). We think a premium for Nike can be justified in view of the uncertainties surrounding the turnaround of Reebok, and Nike’s greater size and profitability. However, we would also highlight that in 2005 and 2006, adidas traded in line or at a premium to Nike due to the former’s greater growth in emerging markets. Looking at consensus estimates for Nike, we expect adidas to record faster earnings growth medium-term (calendar 2012-14e EPS CAGR of 22% for adidas vs. 13.5% for Nike).

Fig. 5: Peer group comparison (closing prices as of 15/01/2013)

2012-14e EPS Last share price Market cap (EURm). EV/Sales EV/EBITDA P/E ratio CAGR 2013e 2014e 2013e 2014e 2013e 2014e adidas EUR 68.18 14,264 0.86 0.77 7.95 6.48 14.82 12.18 21.9% Nike USD 53.19 28,705 1.60 1.50 10.78 9.83 19.14 16.86 13.5% Puma EUR 230.50 3,477 0.87 0.77 7.49 6.29 15.64 13.74 24.5% Under Armour USD 48.34 3,007 2.28 1.80 16.47 12.51 32.44 25.85 24.8% Asics JPY 1,396 2,340 0.80 0.75 7.74 7.13 20.34 17.91 12.9% Skechers USD 18.19 713 0.34 0.28 5.36 3.86 21.40 14.67 n/a Lululemon USD 68.60 7,867 7.14 5.59 23.10 18.53 31.85 25.55 23.7% Sector mean 1.39 1.20 10.62 8.94 21.89 18.59 ADS premium vs. sector (38%) (36%) (25%) (28%) (32%) (34%) ADS premium vs. Nike (46%) (48%) (26%) (34%) (23%) (28%)

Source: IBES; Bryan, Garnier & Co ests.

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Fig. 6: Evolution of adidas’s forward PE premium / (discount) to Nike

30%

10%

-10%

-30%

-50% Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13

Source: IBES

2.5. Already an out-performer in 2012 adidas’s share price is up 28% in the past 12 months, out-performing the Stoxx 600 Household and Personal Goods index and the wider Stoxx 600 index. As shown in Fig. 7, the out-performance relative to main peers Nike and Puma is even greater given adidas’s superior operating performance.

Fig. 7: 12-month share price performance

30% 28.3%

25%

21.4%

20%

15.6% 15%

10% 7.0%

0.8% 0% adidas Stoxx 600 HPG* Stoxx 600 Nike Puma

Source: Datastream *Stoxx 600 Household and Personal Goods index

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3. Top-line should remain robust In this section, we highlight: 1). the fact that medium-term consensus sales growth estimates for adidas are largely achievable as they imply less than 6% CAGR in 2012-15e vs. +10% FX-neutral in the period 2009-12e; and 2). adidas’s fundamentals are very solid, especially in key growth markets.

3.1. 2015 group sales target looks prudent; and consensus is clearly achievable During adidas’s investor days in the US last September, management simply confirmed the group’s 2015 sales target of EUR17bn, although with a different brand mix (Reebok EUR2bn vs. EUR3bn previously, adidas brand EUR12.8bn vs. EUR 12.2bn and ‘Other businesses’ EUR2.2bn vs. EUR1.8bn). We still think this target is conservative as it implies a 2012-15e sales CAGR of 4.3% for the group, after 10% FX-neutral sales growth on average in 2009-12. Whilst our and consensus estimates are above guidance (sales of EUR17.72bn and EUR17.56bn respectively in 2015), they imply a 2012-15e CAGR of 6%, still clearly lower than the average of the past three years.

The adidas brand target stands out as being too conservative.

Specifically within group sales guidance, we find the adidas brand’s target of EUR12.8bn sales by 2015 particularly prudent as it implies a 2012-15e CAGR of 3.7%, assuming 2012 sales of EUR11.48bn. This comes after average FX-neutral sales growth of 12% p.a. in the period 2010-12. Fig.8 illustrates the strength of the adidas brand, as it compares the brand’s FX-neutral sales growth to global GDP growth. Only once (in 2009) in the past 12 years has adidas’s growth under-performed GDP growth, which was in a year when China sales declined 16% as a result of de-stocking after the Olympic Games.

We anticipate a 2012-15e sales CAGR of 6% for the adidas brand. As we highlighted above, 2013 should be a year rich in innovations, which should more than compensate for the dearth of major sporting events. In 2014, the football World Cup held in Brazil should be a key global event where sporting goods brands will be in the spotlight. Fig. 8: Brand adidas’s FX-neutral sales growth and global GDP growth

20%

15% 15% 14% 14% 12% 12% 12% 10% 10% 9% 8% 7% 6% 5% 5% 5% 5% 5% 4% 5% 4% 4% 4% 4% 5% 3% 3% 4% 3% 2% 2%

-1%

-5% -5%

-10% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012e 2013e 2014e 2015e

adidas brand Global GDP

Source: Company Data; IMF

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Too early to judge Reebok guidance.

One cannot yet say whether Reebok’s sales guidance of EUR2bn by 2015 is conservative. It implies a 2012-15e sales CAGR of 7.8% on our ests., and based on the performance of the past two years, there is not enough evidence to suggest it is feasible. Sales grew 6% FX-neutral in 2011, and should decline 6% in 2012 on an underlying basis (excluding licences and India, as explained later). Whilst 2013 should be a better year thanks to product launches, Reebok needs to establish some regularity in its performance. Our estimate for EUR1.93bn sales in 2015 is a touch below guidance, but we would highlight that Reebok should make up only 11% of group sales in 2012 on our ests., and therefore the impact at group level of any disappointment should not be over-estimated.

Our estimates by region seem relatively conservative.

Looking at our 2013-15 estimates by region, we remain relatively conservative in both mature and emerging regions, which strengthens our confidence in the fact that consensus and our expectations are achievable. In Western Europe, we assume low-single digit growth, except for in 2014 which will be boosted by the football World Cup. In North America, the sales growth acceleration in 2013 vs. 2012 is explained by the non-repeat of Reebok’s NFL licence loss. Meanwhile in emerging markets, we factor in a deceleration in the growth rates of the past few years. Fig. 9: FX-neutral sales growth estimates by region

YE 31st Dec (EURm) 2009 2010 2011 2012e 2013e 2014e 2015e Western Europe -5% 7% 10% 3% 2% 5% 3% European emerging markets 1% 16% 22% 18% 10% 8% 8% North America -10% 12% 15% 2% 8% 6% 6% Greater China -16% -2% 23% 14% 10% 8% 8% Other Asian markets -3% 6% 5% 7% 8% 6% 6% Latin America 19% 14% 10% 10% 6% 12% 6% Total sales growth -6% 9% 13% 7% 6% 7% 5%

Source: Company Data; Bryan, Garnier & Co ests.

3.2. 2013 driven by innovations A number of sporting goods retailers, including Footlocker and Finish Line, told investors during the summer that they were happy with the product pipeline of major vendors going into 2013. Our own contacts with smaller retailers confirmed this view, adding that the major brands seem to be ahead of the pack with regards to technological innovations. Innovations are particularly important in years with no major sporting event such as the European Football Championship or the World Cup, which will be the case in 2013. Fig. 10 shows the main product launches for the last quarter of 2012. Fig. 10: Main product launches in Q4 12

Brand Category Product adidas Basketball D Rose 3 shoe adizero Crazy Light 2 shoe Football adizero F50 shoe with miCoach Speed_Cell Reebok Training CrossFit Nano 2 Camo shoe RealFlex Transition 2.0 shoe Running ZigKick shoe Classics Freestyle Hi AK shoe by Alicia Keys TaylorMade Irons Rocketbladez

Source: Company Data

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We do not yet have full details of product launches in 2013. For the adidas brand, the lightweight adizero concept will continue to play an important role as new products will be launched across categories. The most innovative launches should however be in the Running category, where CEO Hainer mentioned a ‘revolutionary’ new technology in cushioning. No details are available at this stage, but it confirms retailers’ comments that 2013 would be a strong year for innovations.

In Golf, after the huge success of Rocketballz in the metalwoods category, TaylorMade launched Rocketbladez in the irons category in November 2012, which management believes will lead to strong market share gains. In 2013, there should be more launches in the metalwoods category, in footwear with adizero, and golf balls.

3.3. Well positioned in key markets In its Route 2015 business plan, adidas’s management highlighted North America, Russia/CIS and China as the key growth drivers, with double-digit sales growth expected every year.

1). Superior performance in China.

adidas stands out as the best-performing major sporting goods brand in the Chinese market at the moment. Fig.11 shows the half-yearly performance in terms of sales growth of the two main Chinese companies (Li-Ning and Anta), as well as adidas and Nike. All brands performed strongly in the run- up to the 2008 Olympic Games (not shown in the chart as adidas and Nike did not split out China sales at the time), but the market then saw a slow-down in consumption, at a time when inventories were high. One can clearly see that Chinese brands won market share in 2009/10, benefiting from lower selling prices and aggressive store openings in lower-tier cities which helped them work through excess inventories.

This trend started to reverse in 2011: Anta’s growth slowed and Li-Ning’s sales actually declined, whilst Western brands’ growth picked up. In H1 12, Li-Ning’s sales decline accelerated and Anta’s sales also dropped. By contrast, both Nike and adidas recorded double-digit growth in that period. For the second half of 2012, based on order backlogs and the performance in Q3 12, the Chinese brands should continue to suffer from double-digit sales declines, but the performance between adidas and Nike should diverge. We expect adidas to maintain sales growth of around 10%, whilst Nike’s growth should slow substantially to low-single digit.

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Fig. 11: Sporting goods brands’ FX-neutral sales growth in China

H2 09 H1 10 H2 10 H1 11 H2 11 H1 12 H2 12e 50%

40%

30%

20%

10%

-10%

-20% Li-Ning Anta adidas Nike

Source: Company Data; Bryan, Garnier & Co. ests

adidas out-performing Nike.

Nike’s sales in Greater China in Q1 13 (June-August) were up 7% FX-neutral (footwear +12% and apparel -1%), but the order backlog for the period September 2012 – January 2013 declined 6% FX- neutral, having already decelerated to +2% at end-Q4 from +20% at end-Q3. During the Q1 13 conference call, Nike’s management blamed a slowing economy and sector-wide excess inventories for the poor performance. It indicated that Nike’s apparel inventories were too high in the region and it was not sure when the situation would normalise. Interestingly, it also admitted that Nike had its own company-specific issues: given the Chinese consumer was becoming more discerning (a trend that Luxury goods groups have also highlighted), the brand needed to improve assortment (specifically fits in apparel) and merchandising, as well as having a greater category focus to improve productivity. In other words, it seems Nike was complacent in China and content with simply leveraging its brand strength, rather than working to offer the right product to the consumer.

By contrast, adidas’s sales in China rose 11% FX-neutral in Q3 12 (July-September), meaning it won market share relative to Nike. We believe growth will continue to be robust in Q4 (double-digit growth expected) as management seems confident with regards to both sell-through to the final consumer and the level of inventories. We highlight two reasons why adidas could be out-performing Nike in the region: 1). adidas took longer to clean up inventories post-2008, which explains why the group returned to growth only in H2 10, 6 months after Nike, and 2). adidas also seems to have placed a greater focus on the Chinese consumer - for example it operates over 1,000 Neo stores, an adidas sub-label to which management thought consumers in China would be particularly suited. Neo has a sport-fashion offering aimed at the 14-19 year-old age group, and carries lower prices.

Chinese brands’ attempt to increase prices failed.

Regarding the former, we believe their strategy to increase prices failed. This strategy was designed to raise the brands’ profile to compete directly with Western brands, and was accompanied by the signing of contracts with top athletes, notably NBA players. The ultimate ambition was to roll-out

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distribution internationally given Anta and Li-Ning make over 90% of sales in their home market. By pushing back those price increases, Chinese consumers sent a clear signal that they were willing to pay a premium for top Western brands relative to local ones. As an illustration, in 2011 Li-Ning’s top price points in footwear reached nearly RMB700, whilst they are now below RMB600, equivalent to adidas’s entry price points.

2). North America improving.

The adidas brand has benefited from good momentum in the US in the past few years. Sales in North America grew 11% FX-neutral in H1 12 (including +15% with the adidas brand), after +15% and +12% in 2011 and 2010 respectively. In Q3 12, group sales actually declined 5%, but this number was heavily impacted by Reebok as adidas brand sales continued to grow double-digit. In terms of market share, according to SGI, adidas brand had a 6% share in US athletic footwear in 2011, up from 5.5% in 2010. We expect this number to increase in 2012. Fig. 12: Evolution of US footwear market share

60%

50%

40%

30%

20%

10%

0% 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Nike adidas Reebok

Source: Company Data; SGI

Basketball revival.

The CrazyLight concept has been a major success for adidas, producing the lightest ever basketball shoe at 9.8 ounces (275 grams). adidas’ US basketball footwear market share rose 3.3 points in 2011 to 8.2% and 5.1 points in H1 12 y/y to 11.4%. It aims for a 20% share by 2015, probably driven by mall-based retailers (which includes Footlocker and Finish Line) as the brand already has significantly higher share in the specialty channel. Sponsoring successful athletes is key to this target and adidas currently has Dwight Howard and Derek Rose under contract. Derek Rose launched his new signature shoe (D Rose 3) on October 4th with a USD160 selling price, and we understand sell- through has been very positive. It is interesting to note that in 2011, only 15% of basketball footwear sales were made in the USD100+ price range. This figure is expected to reach 44% in 2012 and 60% in 2013, which highlights the success of the lightweight concept and the renewed appeal of the adidas brand.

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Focus on high-school kids is paying off.

Management’s strategy to focus on the 14-19 age group seems to be paying off. There are 16m high- school kids, who account for some 50% of US sporting goods sales (the market is estimated at USD41bn), and influence other age groups with regards to spending patterns. Progress has been made as high-school kids focus channels represent about 62% of 2012 sales vs. 40% in 2009, including malls at 27% of US sales vs. just 6% in 2010. Re-enforcing this strategy, the adidas NEO label has partnered with singer Justin Bieber and singer/actress Selena Gomez, both very popular with teen- agers.

The target is to get closer to Nike.

The group aims to hold a clearer number 2 spot in the US for 2014/15. adidas Group had 10.8% market share in 2011, far behind Nike’s 44.2% and ahead of Skechers’ 7% share. In 2013, sales should be driven by the running category (with major launches in the specialty channel in H1 and a more lifestyle-driven version in H2 in malls) as well as basketball with more lightweight products.

In 9M12, average selling prices for adidas footwear were up 21% in the US vs. just 5% for the industry average, showing the appeal of the adidas brand.

3). Russia is still booming.

On Sunday 25th November 2012, Herbert Hainer told the German newspaper ‘Die Welt am Sonntag’ that sales in Russia/CIS would reach EUR1bn in 2012, one year ahead of schedule.

As part of the Route 2015 business plan, sales in the region are expected to grow at a double-digit rate p.a. until 2015, driving it to the third largest region behind the US and China. The group plans to have 1,200 DOS in the region by 2015 (vs. an initial target of 1,000 DOS communicated in 2010 in the Route 2015 strategic plan). This should help adidas in its target to reach a group EBIT margin of 11% by 2015 given the high profitability of Russia (not quantified, but we estimate it at twice the group average) thanks to a good product mix and low labour costs.

We believe adidas has a sustainable competitive advantage in Russia. adidas Group holds over 60% market share in the region and aims for 70% by 2015. As retail sales should account for >90% of sales, adidas is seen as a strong tenant by mall developers and it can thus negotiate the best locations and favourable rents. Moreover, adidas started sponsoring Russian sports federations since the 1960s and has the contract for the Russian football team until end-2018. We do not see a significant threat from Nike (which has just over 100 stores in Russia vs. around 850 for adidas) given adidas has made Russia/CIS a priority market in its Route 2015 plan, whilst Nike is focusing on markets like the US, China and Brazil.

We see Rouble weakening as the main threat for adidas in Russia. The Rouble weakening in 2008/09 wiped out EUR200m in group EBIT. Whilst adidas would certainly not be immune in the short-term should such an event re-occur, the group believes it could eventually offset the impact by increasing prices (they are currently c.10% higher than in Western Europe vs. a differential of c.30% for Inditex). Also, 50% of rents are now denominated in Rouble vs. only 10% in 2008, meaning the FX impact on the bottom line would be lower.

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3.4. Reebok should grow again in 2013

1). A poor 2012, leading to a mid-term guidance downgrade. We believe 2012 was ‘written off’ given there were a number of elements weighing on Reebok’s performance which incited management not to launch any major new products on the heels of the success of EasyTone, Zig and Flex. These negative elements were: 1). the fraud detected in the Indian market (c.EUR100m sales for Reebok), translating into minimal Reebok sales for the last nine months of 2012 in that market; 2). the non-renewal of the NFL licence (won by Nike) and the transfer to adidas-owned CCM of the NHL licence (c.EUR300m sales); and 3). high inventories of Toning product in the market, especially for Reebok’s main competitor Sketchers.

We expect Reebok’s FX-neutral sales to decline 23% in 2012, of which 17% is linked to the non- renewal of the NFL licence, the transfer of the NHL licence and the sales decline in India. During the investor day last September, management cut Reebok’s 2015 sales target to EUR2bn vs. EUR3bn previously. About EUR300m of the EUR1bn shortfall is linked to the transfer of the NHL licence and the non-renewal of the NFL licence. EUR100m is linked to the problems in India, which is expected to recover only slowly. The remainder is linked to poor performance and the decline of Toning relative to 2010 expectations.

2). 2013 should be brighter. 2013 should see sales grow again at Reebok thanks to a number of new product initiatives.

• A new technology in EasyTone. EasyTone inventories for Reebok have normalised in North America, and should be healthy in Europe by year-end. Management still believes Toning is a valid category, backed up by consumer research showing a high proportion of re-purchase intent (86% in Europe for EasyTone); • In Running, there will be a new iteration of ZigTech with a carbon fibre plate, and the Sublite lightweight category will be expanded. In terms of sub-categories, Reebok will launch ATV (All-terrain vehicle), an innovative outdoor shoe featuring outward-facing pods, and a cushioning technology yet to be unveiled; • In the Lifestyle category, Reebok will focus on products that build on its Fitness heritage. The brand is marketing a collection in partnership with Alicia Keys, and aims to double Reebok Royal in 2013, a range that sells for EUR50-70 but still has higher than average margins. We note Lifestyle sales grew double-digit Q3 12; • In Fitness, the Spring/Summer 2013 apparel collection has received positive feedback from retailers, according to management. The focus is to continue to roll-out its partnership with CrossFit gyms around the world, of which there are currently around 5,000, in order to reinforce the brand’s association with Fitness.

Whilst Reebok will have to demonstrate it can be successful in lightweight and outdoor given it lacks the performance image of adidas and Nike, we think a focus on fitness can certainly pay off as it has heritage in that business. A fitness-inspired lifestyle offering can also work in our view, as long as it is built on the brand’s DNA.

3). Building category franchises.

Reebok now has 5 clearly defined business units (Running, Fitness, Walking/Toning, Studio and Lifestyle), which signals a focus on building categories rather than product franchises. Reebok’s focus

adidas on Fitness and Lifestyle makes sense to us in that it builds on past heritage and makes it complementary to adidas’ positioning in pure performance, but the brand still has some way to go to on its journey towards offering a strong product line-up and engaging with consumers.

Regarding the product offering, we highlighted above the key launches in 2013 in the main categories. The new category is called Studio and includes Dance and Yoga. In our view, this fits in well with Reebok’s past in Aerobics and the image it is trying to portray. Reebok’s CMO, Matt O’Toole, indicated there were 15m Latin dance participants worldwide and the company will launch a new version of its Freestyle shoe next year, targeting this population. In Yoga, Reebok will use Tara Stiles as its ambassador in order to conquer this market, in which Lululemon built its success.

Reebok is currently testing stores in New York, Moscow and some Asian countries to showcase the image and positioning of the brand with the various product categories. Reebok’s most successful market is Russia, where the retail channel is dominant, suggesting a targeted retail expansion is helpful to improve Reebok’s image and portray the brand the way the company wishes to. In the first 9 months of 2012, Reebok’s same-store sales are up 9%, and growth accelerated quarter after quarter.

3.5. TaylorMade powering ahead TaylorMade is the global leader in the EUR6.8bn golf market with a 15% market share in 2011. We estimate TaylorMade represents 9% of 2012 group sales on our estimates and 12% of EBIT given the company’s EBIT margin is already at 11%.

TaylorMade had a spectacular 2012 with FX-neutral sales growth of 21% in 9M 12. This was driven by the launch of Rocketballz in the key metalwoods category. In various tests, Rocketballz drivers were shown to add close to 17 meters to the average drive, a significant advantage for players, which led to a quasi-doubling of market share to around 50% in US metalwoods.

More importantly, the product pipeline is strong. At the end of 2012, Rocketbladez was launched in the irons category, which should boost the current 25% market share. Rocketbladez includes a technology that increases ball speed and distance, especially on mishits. In metalwoods, TaylorMade just recently launched R1, the new version of Rocketballz, which adds a further 10 yards to the average drive: this launch should consolidate or strengthen TaylorMade’s already-high market share in the category. Other innovations are expected in balls and footwear with the adizero concept. The company has visibility until at least 2014 in terms of technological innovation, so we suspect TaylorMade will continue to roll out strong products over the next couple of years.

Fig. 13: Estimates by brand

YE 31st Dec (EURm) 2008 2009 2010 2011 2012e 2013e 2014e 2015e adidas sales 7,821 7,520 8,714 9,867 11,481 12,151 12,996 13,645 % growth -4% 16% 13% 16% 6% 7% 5% Reebok sales 1,717 1,603 1,913 1,962 1,596 1,650 1,777 1,931 % growth -7% 19% 3% -19% 3% 8% 9% Other businesses sales 1,243 1,240 1,361 1,515 1,854 1,939 2,025 2,141 % growth 0% 10% 11% 22% 5% 4% 6% HQ sales 18 18 2 0 0 0 0 0 Total sales 10,799 10,381 11,990 13,344 14,931 15,740 16,798 17,717 % growth -4% 15% 11% 12% 5% 7% 5%

Source: Company Data; Bryan, Garnier & Co ests.

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4. Significant margin potential During the US investor days in September 2012, management re-iterated guidance for an operating margin of 11% by 2015. Our new estimates reflect the fact that management will indeed achieve this target. We understand the market’s scepticism insofar as adidas had already stated in 2005 that it would achieve an 11% EBIT margin by 2009, and fell way short. However, we believe adidas is in a stronger position now, despite a lack of visibility on the Reebok turnaround.

Furthermore, the 11% EBIT margin guidance will not all be back-end loaded as management indicated it expects a 100bp improvement to about 9% in 2013. As we explain further below, this should be helped by an easier sourcing environment and continued price increases at the higher-end of the spectrum, where price elasticity has been shown to be low in the past year with limited push- back by consumers thanks to product innovations.

4.1. Mid-term margin guidance is looking increasingly realistic Brand mix means the profitability target will be easier to reach.

We think one reason why management seems more confident than ever in its ability to reach the 11% EBIT margin target by 2015 stems from the fact that Reebok will be a smaller part of the pie than initially planned. During the last investor day, Reebok’s sales guidance was cut (to EUR2bn in 2015 vs. EUR3bn previously), yet Reebok has lower profitability than the group average. Margins are not disclosed at the EBIT level, but Reebok’s gross margin was 11 points below adidas’ in 9M12 (35% vs. 46%), suggesting Reebok should be loss-making this year. Reebok’s lower contribution to sales explains why the brand mix should now be more positive than in the original Route 2015 plan, which is a boost to group profitability.

There are a number of levers to increase profitability.

The 11% EBIT margin target should be reached through both gross margin expansion and opex leverage, although management does not want to give any specific guidance in that respect.

Here are the main levers which should drive margin expansion over the next three years:

• Emerging market growth: emerging markets will represent some 35% of sales this year and over 50% of EBIT on our estimates. Therefore, the fact that emerging markets should grow faster than developed markets (high-single digit vs. mid-single digit in the next 3 years on our assumptions) is positive for profitability; • SKU reduction: management aims to cut the number of SKUs by 25% by 2015 vs. 2010, of which about 10% has already been achieved. The ‘global foundation range’, which are products that are sold worldwide, only represents c.25% of sales, and a target of 50% is deemed reasonable medium-term; • Reebok improvement: Reebok’s gross margin is expected to improve by at least 500bps into the low-40s (vs. 36.3% in 2011) thanks mainly to an improved product mix. As we discussed above, the main driver in 2013 should be product launches in successful categories (Zig, Flex, Toning) and new concepts, with footwear price points of USD100 or above;

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• Shared services: including the regional consolidation of back-office functions like accounting and invoicing; • Logistics: warehouse consolidation is the main initiative which will drive efficiencies. For example in H1 13, adidas will open its new central distribution centre in Osnabruck, Germany, which will handle all of Western Europe, and which will enable the group to close five regional warehouses. This new center should handle 100m pieces p.a. by 2015 for adidas, Reebok and Rockport brands. In 2011 in the US, adidas already shifted TaylorMade and Rockport’s distribution to the group’s Spartanburg facilities (which itself was the result in 2009 of the consolidation of 5 distribution centers); • Retail efficiency: management is ahead of initial plans and now aims for an EBIT margin above 25% in 2015 (vs. 24% previously and 21.2% in 2011).

The group’s margin target looks realistic.

Based on our assumption that adidas’ gross margin will rise to 48.8% in 2015 vs. 47.4% in 2012e, we judge that the implicit evolution of the group’s opex ratio needed to reach the 11% EBIT margin target is perfectly reasonable. Fig. 14 shows the historic evolution of this ratio since 2005 - the group’s best performance was reached in 2006 (37.3%), the first year of Reebok’s integration, and the worst performance was, unsurprisingly, in 2009 (42.3%). Since 2009, the cost ratio has gradually dropped to 40.8%e in 2012. We forecast the opex ratio will fall to 39.2% in 2015, which seems achievable within the historic context, especially as sales should be nearly 80% higher in 2015 than they were in 2006 (EUR17.9bn in 2015e vs. EUR10.1bn in 2006). We expect cost efficiencies and operating leverage to be visible across all cost items in the P&L (logistics, finance & administration and even leverage on the marketing ratio).

Fig. 14: Evolution of adidas Group’s opex/sales ratio

44%

43%

42%

41%

40%

39%

38%

37%

36% 2005 2006 2007 2008 2009 2010 2011 2012e 2013e 2014e 2015e

Source: Company Data; Bryan, Garnier & Co ests.

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4.2. Gross margin: good resistance in 2012; 2013 looking better We expect a 10bp gross margin decline in 2012 to 47.4%, followed by a 40bp increase in 2013 to 47.8% in spite of the lack of a major football tournament.

1). A flat gross margin expected in 2012 in spite of higher input costs.

After an 80bp gross margin decline in H1 12 to 48%, the Q3 margin turned around (+30bps to 47.4%) and we expect a further improvement in Q4 (+50bps) to leave the 2012 gross margin virtually unchanged. In our view, this constitutes a solid performance in the context of strong input cost increases. In the first nine months of 2012, adidas Group’s gross margin declined 40bps to 47.8% in spite of a 410bp negative impact linked to input costs, mainly from higher wages in Asia, but also the spike in the price of cotton last year. adidas therefore managed to offset this significant headwind by increasing prices (up to 15% on higher-end products), and thanks to higher growth in emerging markets and the retail channel relative to wholesale. We believe the former point demonstrates the adidas brand’s pricing power as the price increases did not have a negative impact on demand.

2). The sourcing environment in 2013 should be easier.

Group CFO Robin Stalker indicated to us that the sourcing environment had become easier going into 2013 after two difficult years (higher input costs had a 230bp negative impact on the FY11 gross margin, followed by -410bps in 9M12). The most important reason for this is the drop / stabilisation of raw material prices. As shown in Fig. 15, we estimate raw materials account for 65% of the cost of goods, wages 15% and the remainder overheads (including transport and manufacturers’ margin).

Fig. 15: Estimated split of adidas’ cost of goods sold

Overheads 20%

Labour 15% Raw materials 65%

Source: Bryan, Garnier & Co ests.

The most important components for adidas footwear are oil-linked derivatives like polyester, rubber and plastic, which explains why the oil price is the best proxy to gauge adidas’s input cost headwinds. As shown in Fig. 16, the oil price rose sharply from 2009 lows, and after a 29% increase in 2010, the average price rose a further 19% in 2011. However, in 2012, the average price should be roughly flat y/y.

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Fig. 16: Evolution of the price of WTI oil (USD / barrel)

150

125

100

25 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Source: Datastream

Cotton, which we estimate represents some 10% of raw materials, has been a focus for the market given the strength of the rise and the subsequent fall. Fig. 17 shows the evolution of the price of cotton, which rose from under 50 cents a pound in 2009 to over USD2 in early 2011. The strong drop since mid-2011 to just over 60 cents started to have a positive impact on input costs in H2 12, and this should continue in 2013.

Fig. 17: Evolution of the price of cotton (USD cents / lb)

250

200

150

100

0 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

Source: Datastream

Fig. 18 recaps the evolution of the oil and cotton price since H1 10. Broadly speaking, adidas sees the impact on its P&L of changing raw material prices about 6-9 months later, explaining why the headwind started to moderate H2 12, and should even turn into a tailwind in 2013.

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Fig. 18: Evolution of the price of WTI oil and cotton (change y/y)

H1 10 H2 10 H1 11 H2 11 H1 12 H2 12 150% 130%

100% 74% 53% 59% 50% 25% 12% 14% 0% 0% -4% -2%

-30% -50% -52%

-100% WTI Cotton

Source: Datastream

Rising wages in Asia should continue to be an issue. Fig.19 shows the average annual wage increase in Asia since 2006 in real terms. In other words, one needs to add inflation to gauge the actual wage increase, which is in double-digit territory. In the period 2006-10, the average minimum wage in China (adidas’s main sourcing market with 35% of footwear and apparel produced there) rose 12.5% p.a. In its plan to boost internal consumption to the detriment of exports, the Chinese government aims to further increase minimum wages in China by 13% every year in the period 2011-15. Wages in other emerging Asian countries are also rising at a double-digit rate, although they remain substantially below China’s.

Fig. 19: Average annual real wage growth in Asia (excluding inflation)

6.7% 6.6% 6.3% 6% 5.7% 5.0%

3.9% 4%

0% 2006 2007 2008 2009 2010 2011

Source: ILO

adidas has continually strived to lower manufacturing costs...

Measures taken to limit the impact of higher input costs include the continued drive towards lean manufacturing, product re-engineering and the shift to lower-cost manufacturing areas (such as Vietnam, Bangladesh and Cambodia). The geographic sourcing diversification tends to be directly handled by adidas’s larger China-based suppliers. As an example, in 2011, of the 245m pairs of footwear produced, 35% were made in China, compared with a proportion of 53% ten years ago in 2001. Fig. 20 shows the average textile worker’s wage in various Asian countries.

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Fig. 20: Minimum hourly wage for textile workers (in US dollars)

China 93 cents Vietnam 52 cents Mexico 50-53 cents Indonesia 35 - 71 cents Sri Lanka 46 cents Bangladesh 21 cents

Source: Institute for Global Labour

...and should also benefit from a number of supportive factors. adidas’s gross margin should benefit from structurally supportive elements in the medium-term, namely channel and market mix. The latter is linked to faster growth in emerging markets (as we highlighted before), whilst the former is linked to faster growth of retail relative to wholesale. adidas aims to increase the portion of sales done in ‘controlled space’ to 45% of the total in 2015 vs. 36% in 2011. Controlled space includes not only directly operated stores and e-commerce, but also franchised stores, shop-in-shops and joint ventures. The actual retail channel (only directly operated stores) represented 21% of sales in 2011, and we expect it to represent 25% of sales in 2015. Given retail gross margins are 23 percentage points above wholesale margins (62.6% vs. 40% in 2011), it should translate into a mechanical 25bp uplift to group margins p.a.

Price hikes are probably the most impactful measure adidas has taken, together with all major sporting goods brands for that matter. adidas started increasing prices selectively on a range of products from Q3 11, focused on higher-end products with double-digit percentage increases, whilst lower-end products were left unchanged due to the commoditised nature of that segment. Prices should increase again in 2013, although at a slower pace than in 2012: for example, Nike’s order backlog for the period December 2012 – April 2013 rose 7%, of which +3% was linked to increased prices and +4% to volumes.

Clearly, consumers accepted price increases in 2012 as Nike’s and adidas’ sales grew at a double-digit rate. We believe the key reason for the success of price increases is product innovation. For example, the lightweight trend was rolled out from Running into other segments including Basketball and Football. US retailers (Finish Line and Footlocker) have confirmed manufacturers’ comments that the product pipeline remained strong, especially from key vendors like adidas and Nike.

As we mentioned previously, Reebok should provide another lever to push adidas Group’s gross margin higher. In 9M12, Reebok’s gross margin was 11 percentage points lower than brand adidas’s (35.1% vs. 46.3%). The gap should narrow thanks to various initiatives including better pricing power thanks to new products, the development of Classics (now 20% of the business vs. 50% when adidas bought Reebok in 2005), growth of apparel and own-retail, and faster growth outside the US.

3). Average EUR/USD hedge rates are quite stable. adidas sources some 90% of goods from Asia and we estimate some 35% of sales are denominated in USD, which means adidas benefits from a weaker USD. The EUR/USD parity is still the most relevant one (we estimate adidas makes close to 30% of sales in EUR), even though Latin American currencies (10% of sales), the Rouble, the Yen and the Pound (mid to high-single digit each) are also important. adidas’ EUR/USD hedge rate for 2013 is around 1.32, about 3% less favourable than the 1.36/1.37 in 2012, which should translate into a c.30bp negative impact on the gross margin. The impact was negligible in 2012 as the hedge rate for 2011 was 1.365.

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5. A healthy balance sheet adidas now has net cash.

adidas’s net debt position peaked in 2006 (EUR2.23bn, equating to gearing of 79%) after the acquisition of Reebok, and declined strongly since 2009 as a result of reduced inventories and an improved operating performance. In 2011, adidas had a net cash position of EUR91m, which we expect to increase towards the EUR2bn mark by 2015.

Fig. 21: Evolution of adidas’s net (debt)/cash position (EURm)

2,000

1,500

1,000

500

(500)

(1,000)

(1,500)

(2,000)

(2,500) 2005 2006 2007 2008 2009 2010 2011 2012 2013e 2014e 2015e

Source: Datastream

The dividend pay-out ratio should continue to rise.

We estimate adidas will generate over EUR2.6bn of cumulative free cash flow in the period 2013-15e. Regarding the use of cash, we doubt whether adidas would make another large acquisition in the medium-term given the ongoing challenge of turning Reebok around. We do however expect the company to continue to buy small brands that can complement the current portfolio (such as Adams Golf in 2012, acquired for EUR53m) or technologies it can leverage across the organisation.

With this in mind, we think management will opt for an increase in shareholder returns. We understand share buy-backs are not a preferred option (although adidas bought back and cancelled 5% of its shares in 2008), so we expect the dividend pay-out ratio to rise. Management has guided for a medium-term pay-out ratio of 20-40%, compared with 31% in 2011. We would therefore expect the ratio to reach 40% by 2014, and we assume in our model that it remains at this level in 2015. However, we do not exclude a further increase in the pay-out ratio beyond 40% or a share buy-back programme in the medium-term, based on adidas’s strong cash flow generation.

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6. Risks to the investment case We believe adidas is better positioned now than it was in 2009 to face macro-economic shocks. In 2012, adidas showed it could withstand the negative impact of rising raw material prices with ‘self- help’ measures (mainly price increases, as discussed previously). Beyond the more obvious general risk of a slow-down in consumer spending, we have identified the two main risks to adidas’s earnings, and the reasons we think adidas is better equipped to deal with them now than before the last crisis.

Rouble weakening.

Russia/CIS should represent 7% of 2012 sales but over 15% of EBIT on our estimates. In 2009, the Rouble devaluation (-18% vs. EUR and -22% vs. USD) cost adidas some EUR200m in operating profit as adidas does not hedge Rouble exposure due to excessive cost. Since 2009, management took some measures to offset the potential effect of a repeat scenario: 1). Price increases: prices in Russia are about 10% higher than in Europe vs. about 25% higher for Zara, suggesting adidas still has some leeway to go further; 2). 50% of rents are now denominated in Rouble vs. only 10% in 2008; and 3). All salaries are now in Roubles.

Inventories build-up.

Historically, a slow-down in sales inevitably led to a build-up in inventories given the company’s relatively low responsiveness to top-line trends. In turn, this led to higher discounting. One of management’s priorities is to increase responsiveness by improving the supply chain and reducing lead times. For example, adidas’s production lead time of 60 days now covers virtually 100% of footwear production and the majority of apparel. The company’s other main initiative in the past few years has been to improve inventory management. This has been achieved by reducing the portion of up-front production and incentivising managers on balance sheet efficiency to avoid a culture of purely pushing sales. Specifically in China, adidas now has greater data feeds from retailers to closely monitor sell-throughs and has developed factory outlets to reduce inventories. adidas’s competitors currently face high inventories in China, which has been problematic in the past. In 2009, the Chinese market was especially hard hit by the sales slow-down and inventories overhang. China was adidas’s worst-performing region in 2009 as sales declined 16% FX-neutral vs. a 6% decline for the group average, impacted by the build-up of inventories ahead of the 2008 Olympic Games in Beijing. Whilst most sporting goods players including Nike, Puma and local brands have been negatively impacted by high inventories in China this year, adidas seems particularly well positioned in this market, as we mentioned before. adidas’s inventories are currently healthy according to the company, which is believable given the brand’s healthy sales trends relative to competitors. Also, adidas went deeper into the clean-up in 2010, explaining why the company returned to growth six months after Nike. Nevertheless, one cannot exclude that adidas would eventually suffer from the knock-on effect of key competitors aggressively discounted stock.

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7. Financials

Fig. 22: adidas P&L statement

YE 31st Dec (EURm) 2007 2008 2009 2010 2011 2012e 2013e 2014e 2015e Sales 10,299 10,799 10,381 11,990 13,344 14,931 15,740 16,798 17,717 % growth 2.1% 4.9% -3.9% 15.5% 11.3% 11.9% 5.4% 6.7% 5.5% Cost of goods sold (5,417) (5,543) (5,669) (6,260) (7,000) (7,854) (8,216) (8,684) (9,071) Gross profit 4,882 5,256 4,712 5,730 6,344 7,077 7,524 8,113 8,646 Gross margin 47.4% 48.7% 45.4% 47.8% 47.5% 47.4% 47.8% 48.3% 48.8% Royalty income 102 89 86 100 93 100 105 113 119 Other operating income 80 103 100 110 98 106 112 119 126 Operating expenses (4,115) (4,378) (4,390) (5,046) (5,524) (6,098) (6,329) (6,657) (6,938) of which D&A (216) (210) (272) (265) (246) (276) (296) (319) (337) EBITDA 1,165 1,280 780 1,159 1,257 1,462 1,708 2,007 2,289 % growth 8% 10% -39% 49% 8% 16% 17% 18% 14% EBITDA margin 11.3% 11.9% 7.5% 9.7% 9.4% 9.8% 10.9% 12.0% 12.9% EBIT 949 1,070 508 894 1,011 1,186 1,412 1,688 1,952 % growth 8% 13% -53% 76% 13% 17% 19% 20% 16% EBIT margin 9.2% 9.9% 4.9% 7.5% 7.6% 7.9% 9.0% 10.1% 11.0% Net financial result (134) (166) (150) (88) (84) (61) (40) (16) 2 Pre-tax profit 815 904 358 806 927 1,125 1,372 1,672 1,955 % growth 13% 11% -60% 125% 15% 21% 22% 22% 17% Taxation (260) (260) (113) (238) (257) (320) (391) (477) (557) Tax rate 31.9% 28.8% 31.6% 29.5% 27.8% 28.5% 28.5% 28.5% 28.5% Minorities (4) (2) 0 (1) 1 0 0 0 0 Group net profit 551 642 245 567 671 804 981 1,195 1,398 % growth 14% 17% -62% 131% 18% 20% 22% 22% 17% Fully diluted EPS (EUR) 2.57 3.07 1.22 2.71 3.20 3.77 4.60 5.60 6.54 % growth 14% 20% -60% 122% 18% 18% 22% 22% 17%

Source: Company Data; Bryan, Garnier & Co ests.

Fig. 23: adidas balance sheet

YE 31st Dec (EURm) 2007 2008 2009 2010 2011 2012e 2013e 2014e 2015e PPE 702 886 723 855 963 1,120 1,280 1,448 1,625 Goodwill 1,436 1,499 1,478 1,539 1,580 1,580 1,580 1,580 1,580 Other LT assets 2,050 2,214 2,189 2,344 2,402 2,402 2,402 2,402 2,402 Total fixed assets 4,188 4,599 4,390 4,738 4,945 5,102 5,262 5,430 5,607 Cash 381 385 850 1,389 1,371 1,371 1,371 1,941 2,567 Inventories 1,629 1,995 1,471 2,119 2,482 2,747 2,880 3,040 3,207 Other ST assets 2,128 2,554 2,164 2,372 2,582 2,920 3,078 3,285 3,465 Total assets 8,326 9,533 8,875 10,618 11,380 12,140 12,592 13,697 14,846 ST debt 186 797 198 273 289 289 289 289 289 Other ST liabilities 2,429 2,848 2,638 3,635 3,992 4,248 4,424 4,648 4,854 Total current liabilities 2,615 3,645 2,836 3,908 4,281 4,537 4,713 4,937 5,143 LT debt 1,960 1,776 1,569 1,337 991 858 397 397 397 Other LT liabilities 716 712 694 750 777 818 839 867 891 Shareholders' equity 3,035 3,400 3,776 4,623 5,331 5,926 6,642 7,495 8,415 Total L+E 8,326 9,533 8,875 10,618 11,380 12,140 12,592 13,697 14,846

Source: Company Data; Bryan, Garnier & Co ests.

adidas

Fig. 24: adidas cash flow statement

YE 31st Dec (EURm) 2007 2008 2009 2010 2011 2012e 2013e 2014e 2015e Net income post minorities 483 551 642 245 567 804 981 1195 1398 D&A 217 215 234 299 270 276 296 319 337 Change in working capital 52 57 (186) 769 96 (280) (124) (148) (156) Other 10 (43) (193) (115) (39) 0 0 0 0 Cash Flow from Operations 762 780 497 1,198 894 800 1,153 1,366 1,578 Capex (392) (245) (341) (215) (251) (433) (456) (487) (514) Net investments (2,633) (67) (140) 37 (102) (57) 0 0 0 Interest received 37 27 37 16 23 32 30 34 40 Cash flow from Investing (2,988) (285) (444) (162) (330) (458) (426) (453) (474) Dividends (70) (86) (99) (97) (73) (209) (265) (343) (478) Treasury shares 6 0 (409) 0 0 0 0 0 0 Change in borrowings 1,099 (424) 402 (415) (165) 0 0 0 0 Capital increase 0 0 0 0 0 0 0 0 0 Cash flow from Financing 1,035 (510) (106) (512) (238) (209) (265) (343) (478) FX (23) (1) 2 7 55 0 0 0 0 Cash flow (1,214) (16) (51) 531 381 133 461 570 626

Source: Company Data; Bryan, Garnier & Co ests.

Fig. 25: adidas estimates by region

YE 31st Dec (EURm) 2008 2009 2010 2011 2012e 2013e 2014e 2015e Western Europe 3,527 3,262 3,543 3,922 4,091 4,157 4,364 4,473 % growth -8% 9% 11% 4% 2% 5% 2% FX-neutral -5% 7% 10% 3% 2% 5% 3% European emerging markets 1,179 1,122 1,385 1,597 1,996 2,196 2,367 2,547 % growth -5% 23% 15% 25% 10% 8% 8% FX-neutral 1% 16% 22% 18% 10% 8% 8% North America 2,520 2,360 2,805 3,102 3,400 3,677 3,897 4,112 % growth -6% 19% 11% 10% 8% 6% 5% FX-neutral -10% 12% 15% 2% 8% 6% 6% Greater China 1,077 967 1,000 1,229 1,552 1,707 1,844 1,992 % growth -10% 3% 23% 26% 10% 8% 8% FX-neutral -16% -2% 23% 14% 10% 8% 8% Other Asian markets 1,585 1,647 1,972 2,125 2,401 2,497 2,638 2,805 % growth 4% 20% 8% 13% 4% 6% 6% FX-neutral -3% 6% 5% 7% 8% 6% 6% Latin America 893 1,006 1,285 1,369 1,491 1,506 1,686 1,788 % growth 13% 28% 7% 9% 1% 12% 6% FX-neutral 19% 14% 10% 10% 6% 12% 6% HQ 18 17 0 0 0 0 0 0 Total sales 10,799 10,381 11,990 13,344 14,931 15,740 16,798 17,717 % growth -4% 15% 11% 12% 5% 7% 5% FX-neutral -6% 9% 13% 7% 6% 7% 5%

Source: Company Data; Bryan, Garnier & Co ests.

adidas

Price Chart and Rating History

adidas

16/1/13 70

35 2010 2011 2012 ADIDAS (XET) Source: Thomson Reuters Datastream

Ratings Date Ratings Price 20/04/11 BUY EUR48.55 23/11/09 SELL EUR36.47 20/06/08 BUY EUR42.12 26/06/07 SELL EUR44.88

Target Price Date Target price 14/06/12 EUR67 13/03/12 EUR62 09/01/12 EUR60 05/10/11 EUR55 09/05/11 EUR63 20/04/11 EUR55 15/09/10 EUR38 31/05/10 EUR33 23/11/09 EUR32 29/04/09 EUR31 16/03/09 EUR32 20/06/08 EUR54 26/06/07 EUR40

adidas

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