The Economist run a cover last week with the title “The business of survival : How COVID-19 will reshape global commerce”. This is exactly what the managements of the companies we are invested in are doing: they make sure that their businesses survive. In a Darwinist approach of survival of the fittest, communication and public relations can sometimes become the collateral damage of this struggle. This is what happened to one of our recent additions to the portfolio, the German sports shoemaker Adidas. In March, the company wanted to make use of the German government’s emergency response to the COVID-19 crisis by holding back rent payments to its shops. That led to a public outcry with a large echo in the press : for example the German finance minister Olaf Scholz, was quoted in the tabloid Bild that it was “irritating when big companies simply announce a halt to rental payments.”
The management of Adidas staid cool and moved ahead in its business of survival. First it dropped the company guidance by stating “that the further development of the coronavirus outbreak and its impact on the company’s business cannot be predicted at this point in time. As a result, adidas is still not able to provide an outlook for the full year 2020 that includes this impact. …”
In April, Adidas received the approval of the German government for the participation of KfW, Germany’s state-owned development bank, in a syndicated revolving loan facility amounting to EUR 3.0bn at customary market conditions to bridge this unprecedented situation. The maturity of the loan is for 15 months to July 2021, but it can be repaid at any time or extended by one year. Again the management of Adidas came in the cross fire of critics arguing that it would be indecent for a company that had generated last year 23.6 bn EUR in sales, 1.9 bn EUR in net profit, bought back stock for 813 mil EUR of its stock and paid out 664 mil EUR in dividend was now asking for state aid.
This is the business of survival. With this loan Adidas does not legally switch under a governmental protection umbrella but uses the opportunity for quickly available liquidity. This comes on top of its already secured EUR2.1bn bilateral credit line and an existing EUR2bn Commercial Paper Program. In order to stay on the high road, dividend payments and share purchases are stopped. Management also foregoes its short- and long-term bonus for the year 2020.
Adidas is now well equipped to weather the crisis. According to Kepler research Adidas now has a liquidity buffer of EUR7.6bn including its cash on the balance sheet even leaving the commercial paper program out. The analysts from Kepler believe in a worst case scenario, the company has a monthly free cash flow burn of some EUR1.4bn. This is understandable as the wholesale and physical retail activities in the company’s main markets usually account for 60% of the company’s business have come to a complete stop. The liquidity buffer would therefore secure the company for six months of lock-down.
Instead of discussing moral hazard, let’s discuss the business of survival. Adidas will survive this crisis while it will need to do efforts on public relations ( which is happening currently if I consider the COVID-19 posts of the company on social media ). In the meantime, the company will focus on strengthening its brands and launching new products.
The stock price has dropped from 316 EUR to a low of 167 EUR during the Corona crisis. We have been using this weakness to start building a position. The stock price has been rebounding to 220 EUR since. Our investment case in Adidas is simple : the CEO Rorsted is a specialist in improving consumer franchises and has made Adidas a desired brand again and he sells more at full price. The company margins have improved from <7% in 2015 to >11% in 2019 which is almost to the closing gap to Nike. Higher margins are sustainable as they come from improved gross margins leaving more room for brand support.
We have in the past had a successful investment in adidas and believe that by securing this loan, Adidas gives itself the financial flexibility not only to survive the crisis but to emerge as a stronger player. Admittingly and may be due to German rigor, the public image and brand may suffer due to mishaps in public relations. But can we really blame the company for that. It is the business of survival !