Financial Report Adidas – Term Paper

Student number: 0880732 Term paper Handelshoyskolen BI – Adidas AG – Exam code and name EXC 25093 Financial Statements and Valuation Hand-in date: 15. 04. 2011 Place of study: BI Oslo Program: Bachelor in Business and Administration Table of contents Summaryii Adidas1 Sports Apparel Industry1 Economic Situation2 – Financial Statement Evaluation2 – Profitability ratios3 – Efficiency ratios4 – Liquidity and cash flow ratios5 – Investment ratios5 Multiple Comparisons Valuation Model6 Forecasting Fiscal Years 2011-20147 – Sales growth7 – EBIT margin7 Inflation7 – Capital Expenditures8 – Depreciation8 – Amortization8 – Net operating working capital8 – Tax and interest income/expense8 Free Cash Flow Valuation Model9 – FCFNOA10 – Beta Equity10 – Cost of equity11 – Weighted average cost of capital12 – Value of equity12 Conclusion13 References14 Appendix 1: Reformulated Balance Sheet Adidas € mill15 Appendix 2: Reformulated Balance Sheet PUMA € mill16 Appendix 3: Reformulated Income Statement17 Appendix 4: Ratios for Adidas18 Appendix 5: Ratios for Puma19 Appendix 6: Multiple analyses21

Appendix 7: FCF Valuation Model: Economic Balance Sheet22 Summary The purpose of this report is to evaluate how the Adidas Group did during the recent three years in respect of financial statements ratio. Furthermore, it will provide an assessment of the intrinsic value of the shares of Adidas AG. The first part of this report will briefly describe Adidas and the industry it’s competing in. Further on, there will be used a cross-sectional analyses to evaluate the performance and to compare Adidas to a competing company.

The chosen company is Puma, due to equal fiscal years. The second part of this report consist of a multiple analysis and a free cash flow valuation model which will provide a valuation of Adidas’s shares. All of the information and numbers are conducted from financial and annual reports. Regarding forecasting the next years, historical numbers are used as a benchmark to predict future development. Adidas AG Adidas AG is a German sports apparel manufacturer, founded in 1948 by Adolf Dassler.

Adidas AG is the parent company of Adidas group, which consists of the Reebok Company, Golf Company and Rockport. In addition to sportswear, Adidas produces bags, watches, eyewear and other sports and clothing related goods. At the moment they are the largest sportswear manufacturer in Europe. On a world basis, they are rank as #2 after American rival Nike, accordingly to Dow Jones Industry: Sports Clothing/Footwear. Adidas strategic goal is to be the leading manufacture within the sporting industry, which will be reach thru several key success factors.

Adidas will strive to create a culture of innovating, challenging themselves and embrace change. In 2010 Adidas announced Route 2015, which is a strategic plan to become the leading sports producer in the world. With respect to shareholders, Adidas AG aims to create value for shareholders and investors through significant cash flow. Adidas mission is as followed: strive to be the global leader in the sporting goods industry with brands built on a passion for sports and a sporting lifestyle. (adidas-group. om) Adidas is a major sports and event sponsor and are the key sponsor and supplier to National Basketball Association (NBA) and the main sponsor to New Zealand’s rugby team. In addition they sponsor some of the major teams in European football such as Real Madrid. Sports apparel Industry The sport apparel industry consists of many players. The four biggest competitive rivals are Nike Inc, Adidas AG, Pou Chen Corporation and Puma AG. When looking at the largest companies, there is a stable but continues growth in their sales and profitability ratios, indicating that the industry can be perceived as stable one.

Furthermore, due to yearly sporting events such as UEFA Champions league, Super Bowl and the enormous interest in sport generally, the demand for sport products are high. The sports apparel industry is perceived to be a difficult industry to enter. The high degree of competiveness and the need of innovating thinking are undeniable. In addition, several incumbents have reached large-scale production and as a result it will be expensive for new entrants to fight for market share.

Many of the producers use famous athletes to front their products. The market powers of such athletes are priceless and help boost their sales. With regard to the financial crisis, looking at profitability ratios and sales, it is visible that the industry and the companies competing in the industry suffered in the sense that their sales decreased compared to previous years. However, due to the FIFA world cup in 2010, their sales numbers where extremely well compared to sales numbers from 2009. Economic Situation

To be able to evaluate the financial performance of Adidas in a more comprehensive manner, Puma has been chosen as the comparing firm. The reason for comparing Puma and not Nike, are due to different fiscal years. Nike Inc ends their fiscal year in May, and both Adidas A and Puma end their fiscal years in December. Comparing Adidas A to Nike could generate bias estimates and there would not be possible to compare fiscal year 2010. Due to the financial crisis in 2009, it could be hard to estimate future growth without having numbers from 2010.

Adidas and Puma prepare their balance sheet according to GAAP. Due to the fact that values are classified according to maturity and liquidity, their balance sheets have been reformed to an Economic balance sheet, which focuses on fair values. This prevents encountering bias ratios. Financial Statement Evaluation The CE formats from the reformulated balance sheets are given underneath. When comparing Adidas to Puma, there is clearly that Adidas have far more financial obligations than Puma.

However, Adidas has decreased their debt obligations by 28,58%. Furthermore, you can see that with respect to Adidas NOA, it has decreased by almost 10%. Puma on the other hand have increased their by almost 2%.

In the past three years, Puma has had a higher ROA then Adidas, indicating that they are doing a better job in converting their investments into profit. Both of the companies ROA have been decreasing the last three years. According to ROE, Puma generates more income earned for every € invested than Adidas in 2009 and 2010. In addition, the ROE for both Adidas and Puma is higher than ROA (except for Puma in 2009), indicating that both companies have leveraged their position. Moving on to Profit margin, which is useful when comparing companies in similar industries.

Puma generates a higher profit margin than Adidas in every year, which give an incentive to say that Puma controls their costs in a better way than Adidas. Puma has a profit margin of 11,50%, meaning that they have a net income of €0,115 for each euro of sales compared to Adidas which only have a net income of €0,0767 for each euro of sales. Moving on to Operating profit margin. Both companies are increasing their ratio; hence they are earning more per euro of sales then before. Nevertheless, Puma outperforms Adidas in every executive year. In 2010 Puma made €0. 1134 for every euro of sales compared to Adidas who made €0. 0746. These figures are before interest and tax. The industry average was 4. 98% in 2010, which is less than both Adidas and Puma.

With regards to profitability, Puma performs better than Adidas. Measuring efficiency

An efficient ratio that is important to consider is asset turnover. From the provided numbers above, you can see that both companies turnover rate were fairly similar. In 2010 Adidas and Puma generated €1,13 and €1,14 of annual sales from each euro of asset that year. Both companies reduced their asset turnover from the year before. The industry had an average of 0. 45. Following is the inventory turnover rate. According to these numbers Adidas turned over their inventory 3,49 times and Puma 3,47 times in 2010. They both increased their turnover rate suggesting strong sales. The industry average in 2010 was 1. 36. The efficiency ratios for Adidas and Puma show a very similar trend.

Measuring liquidity and cash flow ratios

The current ratio implies that Puma has a greater liquidity than Adidas, hence are in a better situation to pay short-term debts.

However, most firms tries not to hold a very high ratio due to the fact that it is costly to hold a greater amount of current assets than necessary. From the ratios given, there is evidence that Puma had a greater current ratio then needed, hence the decrease from 2009. Adidas has held a steady current ratio the last three years. The industry average in 2010 was 1. 26. The next ratio that will be discussed more in detail is the quick ratio. Adidas’s ratio were in 2010 less than both Pumas and the industry average (0. 98) which might be concerning for an analyst. However, by studying Adidas’s balance sheet more in debt, their cash balance is increasing more than their short-debt is, so their quick ratio can be expected to rise to a more acceptable level.

With emphasis on the quick ratio, Puma is in a far better situation in meeting their obligations without having to liquidate or being dependent on their inventories. The overall conclusion after interpreting these ratios is that Puma is doing a more acceptable job than Adidas.

Investment Ratios

According to the P/E ratios calculated above, investors are more likely to invest in Puma since they have a higher P/E ratio than Adidas. Puma’s stocks in 2010 were selling for about 18. 43 times its current EPS. However, the difference between Adidas and Puma is minimal. The industry average P/E was in 2010 10. 95, hence both companies have more growth potential than many of the companies competing in the industry. Furthermore, the dividend yield is another imperative ratio that needs to be considered with respect to investment. In 2010, Adidas and Puma paid an annual dividend of €0,80 and €1,80 respectively. Adidas was trading for €48,89 and Puma was trading for €248.

If keeping all other factors equivalent, Adidas has a better dividend yield than Puma and investors would prefer Adidas to Puma. The industry average was 1,09%, which is above Pumas dividend yield but less than Adidas. Multiple Comparison Valuation Model The next step is to valuate the shares of Adidas AG using the Multiple Valuation model. The companies chosen for this is Puma and Nike. As mentioned earlier, Nike Inc ends their fiscal year in May. Do to this factor, the figured used are from May 2010. In addition, Nike Inc is valued in USD, which have been transformed using the exchange rate 31. 05. 2010. In Pumas case, share price from 30. 12. 2010 have been used. € in mill

Forecasting Fiscal Years 2011-2014 Sales growth

When calculating future sales growth, historical numbers have been used to get an incentive about possible future trends. The historical sales growth (2006-2010) has been to some degree volatile. There are multiple reasons, which can shed light on this trend. Due to the financial crisis starting in 2008, Adidas had a decrease in sales of -3,88% in 2009. In 2010, they experienced a positive growth rate of 15,51%. The reason for this high rate can be related to the 2010 FIFA world cup, so estimating using this rate would generate bias growth rates. For this reason that sales growth in 2011 is estimated to be 4,65% (average 06-10). In 2012, the growth rate is 10% due to the upcoming UEFA Euro 2012 cup.

In 2013 and 2014 the sales growth rates are 5,00% and 6,00% respectively. EBIT Margin The historical EBIT margin (2007-2010) has been on average 8,62%. According to Route 2015, one of Adidas goals is to outgrow their major competitors over the next five years, which will result in an increase in marketing and operations as well as sales. The EBIT margin was in 2010 7,46%. This is expected to increase to 8,62%, (average 07-2010) in 2011, and then increase till 9% in 2012,2013 and 2014, respectively. This is due to the fact that sales are expected to grow as stated previously. The EBIT margin will not grow in accordance to sales growth due to increased variable costs. € in mill

Inflation Since Adidas is the leading manufacturer in Europe, the historical inflation for the Euro area has been used as a benchmark to predict future inflation rate. The average inflation (2008-2010) was 1,62%. The average inflation in 2011 so far is 2,4%, increasing from 2,30% in January till 2,60% in March.

The inflation has been relative volatile the last years, possibly due to the financial crisis. The economy is more stable now and the same is expected with respect to the inflation rate. Hence the future inflation rate is set to be 2%, which is the average for 2010 and the three first months of 2011. Capital Expenditures CAPEX have remained relatively stable the last four years with expectation of 2008. Average CAPEX, has been €292 mill. This is relative high due to the fact that it was €376 mill in 2008. Route 2015 will probably increase CAPEX from years 2009 and 2010, where it was €241 mill and €269 mill, respectively. Hence it is likely to predict that it will increase to €270 mill. Depreciation

Depreciation is recognized utilizing the “straight-lint method” except where the “declining-balance method” is more appropriate in light of the actual utilization pattern (Adidas AG annual report 2010). Depreciation has fluctuated from €145 mill to €198 mill in the last four years. Due to Route 2015 plan, depreciation is expected to increase by a small amount the next four years. Amortization Amortization has been relative stable the last four years except during the financial crisis; hence amortization expenses are expected to remain at €71 mill. Net Operating Working Capital NOWC has shown a stable but slightly upward sloping trend the last years.

NOWC was 20,07% of total sales in 2010 which should provide Adidas with sufficient liquidity. In light of the previous trend, there is reason to assume that Adidas will increase NOWC to 21% for perpetuity. Tax and interest income/expense The German corporate tax rate is 15% but Adidas uses 29,53%, hence future tax shield on net int. expenses is calculating using 29,53%. Furthermore interest income and expense are based on average from the years 2007-2010, and are calculated to be 25,75 and -148,5, respectively. Even thought there have been some fluctuations the last years, this is kept constant due to the fact that numbers are based on years where the financial crisis and FIFA world cup occurred. € in mill

Free Cash Flow Valuation Model Moving on to evaluate the share price using the free cash flow valuation model. In this model, the assumptions about inflation, capital expenditures, depreciation, amortization and net operating working capital as well as NOPAT are used. FCFNOA € in mill

In the table below is the equity beta for Adidas, which is necessary to be able to calculate they weighted cost of capital (WACC) and the equity value for Adidas. The equity value of Adidas is found by discounting the future free cash flow that is provided at the end of this report. Beta equity Adidas

Moving on to calculating the cost of equity. The risk-free rate is based on German government bond. The tax rate is based (as previous stated) on the one Adidas are currently using.

The borrowing rate is the average borrowing rate to Adidas the last 5 years, which gives a good estimate. The market risk premium (MRP), and premium (size/liquidity) are based on the average of the market.

In order to calculate WACC in a correct manner, the following factors where included; equity, financial assets and obligations. The result is in the table underneath. Weighted Average Cost of Capital calculation:

Determining the value of Equity

According to the FCF valuation model, the value of equity is 7,313,000. On 31. 12. 2010 there were 209,216,190 outstanding shares. This results in a stock price of €34,95. However, the stocks were traded at €48,89, hence implying that the stock price was overpriced. The Multiple Valuation Model on the other hand, gives a higher stock price then it was trading for. Conclusion

After conducting all the analyses, the results shows that Adidas is not performing as acceptable compared to Puma. In addition the results shows that their stock is traded above its intrinsic value per 31. 12. 2001. It would not be recommended to buy stocks at this stage. However, Adidas has managed to reduce their financial obligations and have increased their sale by impressive 15,51%, compared to Puma which increased their sale by 10,5%. In addition, even though Adidas is less efficient than Puma, their ratios show a positive increasing trend and growth prospects.

References:
Web-pages:
– http://adidas-group. Accessed 30. 03-14. 04-2010
– http://www. trumarkets. com. au Accessed 12. 04. 2010
– http://www. radingeconomics. com Accessed 10. 04. 2010
– http://uk. finance. yahoo. com/ Accessed 11. 04. 2010
– http://www. reuters. com/ Accessed 30. 04. -14. 04-2010
– http://www. bondsonline. com Accessed 14. 04. 2010
– http://www. puma. com Accessed 02. 04. -14. 04-2010
– http://www. nike. com Accessed 14. 04. 2010
– http://investopedia. com Accessed 11. 04. 2010
– Factiva-database Accessed 30. 04-14. 04. 2010

Reports:
– Annual Report 2007 of Adidas
– Annual Report 2008 of Adidas
– Annual Report 2009 of Adidas
– Annual Report 2010 of Adidas
– Annual Report 2007 of Puma
– Annual Report 2008 of Puma
– Annual Report 2009 of Puma
– Annual Report 2010 of Puma

Books:
– Leonard and Robin Soffer. 2003. Financial Statement Analysis, A valuation Approach. New Jersey: Prentice Hall.
– Sutton, Tim. 2004. Corporate Financial Accounting and Reporting. 2nd ed. Essex, England: Prentice Hall
– Garrisons, Ray. , Noreen, Eric. , and Brewer, Peter. 2008: Managerial Accounting. 12th ed. New York, US; McGraw-Hill/Irwin
– Harrisons, Walter, and Horngreen. Charles 2008. Financial Accounting. 7th ed. New Jersey: Pearson Education.
– Johnson, Gerry. , Scholes, Kevan. and Whittington, Richard. 2009; Exploring Corporate Strategy. 8th ed. Essex, England; Pearson Education. Appendix 1: Reformulated Balance Sheet Adidas

Appendix 2: Reformulated Balance Sheet PUMA

Appendix 3: Income Statement Income Statement Adidas

Appendix 4: Ratios for Adidas

Appendix 5: Ratios for Puma