STRATEGY OVERVIEW
Sportswear: Industry Background
Nike, Adidas and Puma are main players in the sportswear industry, holding 80% of the market share (Kissane, 2017). The sportswear industry was valued at US $78 billion in 2016 (Kissane, 2017), and the apparel and footwear market is rapidly expanding. The European and U.S. markets are booming, with Chinese markets continuing to develop. (Adidas AG, 2016) (Puma SE, 2016)
Puma AG
Puma designs, develops and sells footwear, apparel and accessories. Their products are distributed in 120+ countries and they employ 10,000+ people worldwide (Puma SE, 2016). Puma also collaborate with renowned design brands to bring innovative designs to the sporting world.
Strategies
Puma’s mission: ‘To be the Fastest Sports Brand in the world’ (Puma, n.d.a) is expressed through all its actions and decisions. Their strategy encompasses five strategic priorities: repositioning PUMA as the World’s Fastest Sports Brand; the improvement of their product engine, optimization of the distribution quality as well as increasing the speed within their organization and infrastructure, whilst renewing the IT infrastructure. (Puma, n.d.a) Recently Puma’s focus has been on developing their female customer base by introducing a women’s shoe and apparel collection in collaboration with Rihanna. (Puma SE, 2016)
Key Success Factors and Risks
Puma’s clearer design, innovative technology and product commerciality drive success, and frequent product launches, e.g. IGNITE (running technology), demonstrate continuous innovation (Puma SE, 2016).
Puma, a member of the Better Cotton Initiative, partners with bluesign technologies to use sustainable materials, building a greener brand (Puma, n.d.b).
Adidas AG
Adidas have delivered high quality products for over 80 years; they employ 55,000 people in 160+ countries, producing over 778 million products every year and generating sales of €17billion (Adidas AG, 2016). Adidas are dominant in similar markets to Puma.
Strategies
Adidas embrace a multi-brand strategy, focusing on 3 main areas: quickly satisfying consumer needs; expansion into different cities; focusing on high potential markets and channels, by inviting high profile individuals to be part of the brand (Adidas, n.d.a). They also focus on sustainability and creating a diverse brand portfolio (Adidas AG, 2016).
Key Success Factors and Risks
Strengths
Adidas operate in ‘2700 own-retail stores, 11,000 franchise stores, 116,000 wholesale doors and nearly 50 own e-commerce sites’, allowing efficient product distribution, and high availability through several channels (Adidas AG, 2016).
Adidas maintains customer relations through celebrity collaboration and sponsoring major sports organizations, e.g. FIFA, NBA and Olympics; thus building their brand and increasing their customer base. (Adidas AG, 2016) Constant innovation has enabled Adidas to continually improve, whilst helping the environment, e.g. using ocean plastics to create shoes (Adidas, n.d.b)
Risks
Although Adidas is a global brand, it faces fierce competition from other brands, e.g. Nike. There is potential for price wars between companies as they experience intense competition. As well as risks relating to organisational structure and change, a heavy reliance on outsourcing production leads to suppliers having more bargaining power than companies. Due to being a global company, it could potentially be affected by currency fluctuations, which could take a huge toll on product prices and profits. (Bhasin, 2016)
RATIO ANALYSIS
This section analyses Puma and Adidas on five key areas: profitability, operating efficiency, investing efficiency, liquidity, and solvency. Ratios are then used to compare firms and analyse trends, highlighting the strategic reasoning behind these figures.
Profitability
Return on Equity (ROE)
ROE indicates the money the company is making as a percentage of their equity. Puma had a low 2015 ROE of 3.8%. This was a significant fall of 1.4%, and well below the industry average of 10.4% for 2015 (Compustat, 2017). Puma’s 2015 net profit fell by 27.2%, causing a decrease in their ROE.
Meanwhile, Adidas saw an increase in their ROE to 11.3%. This increase in ROE could also be directly attributed to a change in their net profit, up by 29%.
Adidas repurchased treasury shares during 2015; despite this, total equity still increased. Repurchasing shares while the company is overperforming can help protect firms against future drops by having the ability to increase equity through resale, increasing shareholder value (Merritt, n.d.).
As Puma’s net profit margin decreased during 2015, they didn’t have this option. This may become an issue for them if they continue to see a drop in profit and their share price falls.
By decomposing ROE using the DuPont approach, we can assess the different factors that impact ROE:
ROE = Net Profit Margin x Total Asset Turnover x Financial Leverage
Using this formula, we can identify key performance drivers for Puma and Adidas.
For Puma, it is obvious that net profit margin hugely impacted their ROE. Despite two of the three drivers increasing- financial leverage and total asset turnover, ROE decreased. A further analysis of net profit margin can be seen below.
Comparatively, Adidas’s ROE increased, up by 28.2%. Again, we note net profit margin having the biggest impact on ROE. Adidas also experienced increases in financial leverage- rising to 235.5% from 220.8%. (Adidas AG, 2016) This increase is attributable to an increase in total assets- primarily non-current assets, e.g. PPE, Goodwill. PPE increased due to the acquisition of a warehouse in Russia, which they previously leased (Adidas AG, 2016). Goodwill value is mostly related to the acquisition of Reebok in 2006 and differs with the varying success of Reebok. (Adidas AG, 2016)
It is important to note the DuPont formulation doesn’t clearly separate operating components from financing. An ROOE breakdown is provided in the appendices, highlighting that Puma has a larger spread than Adidas. This is because Puma have negative levels of net financial liabilities in 2014, due to low levels of short term borrowing (Puma SE, 2016), however this figure has since become positive and this spread might be expected to decrease in future years.
Operating Efficiency
Net Profit Margin
Net profit margin is a measure of operating performance. Puma’s net profit margin in 2015 was 1.82%, this was a decline from the previous year’s margin of 2.85%- “unfavourable exchange rate effects had a negative impact on other operating income and expenses” (Puma SE, 2016). Puma is a global company operating in many different countries, meaning their financial performance is sensitive to exchange rate volatility. The USA is a major market, the strengthening of the dollar (Gillespie, 2015) suggests that, any expenses incurred in the U.S will be costlier than previously due to reporting in Euros. This is further proved by an increase in the cost of sales year on year from 2014 to 2015.
Adidas saw a slight increase in their net profit margin in 2015, up 0.37% to 3.78%. Like Puma, Adidas experienced increases in operating expenses attributed to higher losses from currency conversion, as they also report in Euros. However, Adidas also experienced increases in net sales due to an increase in royalty income from associated companies (Adidas AG, 2016). Adidas have many affiliated companies, such as TaylorM
ade, (Adidas AG, 2016) and have income from a wider product range than Puma. This suggests that Adidas are a more diversified company than Puma.
Investing Efficiency
Trade Receivables Turnover
Trade receivables turnover looks at how efficiently credit payments are collected. For Puma in 2015, this was 7.27, an increase of 6.8% on 2014. Adidas have a significantly higher receivables turnover ratio of 8.47- also an increase on the 2014 figure of 9.4%.
Puma attributed their rise in receivables turnover to a rise in fourth-quarter sales (Puma SE, 2016). We can assume that Adidas’s increase was also due to such an increase, as they also experienced an increase in sales during their fourth quarter. 30.5 % of Adidas’ new sales were made on credit- a driving factor of the increase in receivables turnover. The proportion of Adidas’ sales made on credit has decreased, so their receivables turnover will increase. Puma reflect this position as the value of Puma trade receivables as a percentage of net sales has also decreased.
In this regard the two companies are reasonably comparable. Despite Adidas being a significantly larger company than Puma, they don’t have an advantage in trade receivables collection efficiency. This may be linked to the similarity in customers, they operate in similar markets thus their potential customers may be matched. Therefore the collection of receivables for both companies may rely on customers with similar credit payment behaviours.
Trade Payables Turnover
Trade payables turnover calculates how many times during the fiscal period payables amounts are paid. For Puma, this was 3.57 in 2014 and 2015, showing the ability to control cash flow to settle payables. Though their turnover didn’t change, average payables increased by 75 million. Puma’s cost of sales increased (due to increased stock levels) proportionally with increases in trade payables. (Puma SE, 2016).
Adidas saw increases in trade payables turnover from 4.38 to 4.76 year-on-year. Cost of sales grew at a much larger rate than average payables; showing Adidas are settling their payables more often than previously. It could be argued that as Adidas are a much larger company, they would hold a higher level of supplier bargaining power and therefore have a lower figure, however, Adidas’s trade payables turnover is significantly larger than Puma’s. This suggests that Puma hold more successful negotiations with suppliers over payment terms.
Total Asset Turnover
The total asset turnover indicates how efficiently a firm employs its assets relative to revenue. Analysis of Puma’s and Adidas’s total asset turnover indicates Adidas deploy assets more efficiently when generating revenue. However, the total asset turnover for both firms has increased, primarily due to an increase in sales.
Puma have reported sales increases in every region, the largest in the America region (Puma SE, 2016). One explanation for this region’s 23% sales increase is a recent marketing strategy promoting Puma by Rhianna (Hegmann, 2016). Their largest source of sales was footwear, which ‘continued a sustained growth trend’. Puma CEO Bjørn Gulden noted significant progress in sports footwear and its growth potential (Hegmann, 2016). Puma also mentioned their ‘Forever Faster’ strategy (Puma SE, 2016), with increased focus on sports performance; this explains the significant growth in footwear and apparel. Puma experienced an increase in average total assets, though this was offset by the increased growth in sales.
Adidas’s total asset turnover also increased, from 1.21 to 1.31. Driven by sales growth, their sales increased by €2,381million, and average total assets also increased (Adidas AG, 2016). Adidas’s increase in assets were attributable to increases in receivables and non-current assets (Adidas AG, 2016). Like Puma, Adidas’s main source of sales growth was footwear with a large increase (23%) compared with other products (apparel increased by 11%, hardware fell) (Adidas AG, 2016).
Regionally, the Americas and Western Europe have a comparable level of sales in 2015, providing most sales revenues. A 20% increase in sales in Western Europe increased net sales for the group. This could be related to a push on sponsorship deals with major European sporting teams, such as Manchester United (Bourke, 2016). This contrasts with Puma, where Western Europe provides a decreased level of sales compared to America.
Liquidity
Current Ratio
This indicates an entity’s ability to meet obligations (short and long-term). A lower ratio shows a firm is less capable in paying its obligations. The retail industry, on average, has high current ratios. For example, Dun & Bradstreet approximated that the average current ratio for an apparel retailer is 1.9 (Guru, n.d.). Using 2015 data, Puma’s current ratio is 1.91, and Adidas’s is 1.4.
Both companies use AVCO when valuing inventory, helping comparability. Puma’s current ratio has decreased from 2 in 2014 to 1.91 in 2015; down 4.5%, due to a 6.6% increase in current liabilities, relative to a 1.2% increase in current assets. The latter was caused by a 127% increase in other current financial liabilities (primarily liabilties from market valuation of forward exchange transactions); offset by decreases in income taxes, other current provisions and financial liabilities.
Adidas’s ratio decreased from 1.7 to 1.4; a comparatively larger decrease of 17.6%. This was fuelled by a 22.5% increase in current liabilities, compared to a 2% increase in current assets (2014-2015). This increase in current liabilities was driven by a 56.5% increase in current financial liabilities due to increases in Sundry relating to purchase price obligations for non-controlling interests and a 34.9% increase in current accrued liabilities, including marketing distribution costs and costs relating to goods and services not yet invoiced.
The two companies had a large difference in short term financial assets. Adidas’s short-term financial assets make up 0.0667% of current assets; Puma’s are 4.56%. If Adidas had a similar level of short-term financial assets, relative to other levels of current assets, their ratio would converge towards the apparel retail average.
Quick Ratio
Inventory makes up a significant proportion of total current assets, greatly increasing the current ratio. The effect of removing inventory is shown when calculating the quick ratio. Using 2015 data, Puma’s quick ratio is 1.17 and Adidas’s is 0.82.
High levels of inventories are expected in the retail industry. However, excessive inventory levels can lead to increased waste and inefficiencies. The importance of achieving optimally low levels of inventory and tighter operating working capital is stressed in Adidas’s 2015 financial statement. Despite this, Adidas’s inventory levels increased by 23.3% due to higher stock levels required to support the Group’s top-line momentum, to ‘shorten order-to-delivery times and ensure availability of products’ (Adidas AG, 2016). Adidas plan to further reduce inventory levels by aiming to ‘bring production back to where the main markets are’ through making more goods in Europe rather than Asia (BBC, 2015). This is mirrored in Puma’s financial statements. Inventory levels increased by 15%, ‘in order to ensure product availability even when demand is strong and meet the increased need for products due to our new retail stores’ (Puma SE, 2016).
Solvency
Liabilities to Equity
This is influenced by changes in total liabilities and ordinary shareholder equity. Analysis of Adidas and Puma’s future obligations relative to equity, shows changes in this ratio were due to increases in total liabilities.
Increased liabilities
inflated the liabilities to equity ratio for both companies: Puma’s increased by 4.3%, Adidas’s by 14.9%.
Adidas implements a strategy with much higher leverage levels than Puma; there are risks and advantages to both strategies. Lower leverage is less risky for the firm but forgoes shareholder returns. This is reflected in Adidas’s annual report: ‘we are committed to increasing returns to shareholders with above-industry-average share price performance and dividends.’ (Adidas AG, 2016). Puma’s increase in liabilities is substantial, despite being lower than Adidas’s and was due to an increase in other current liabilities; increasing from €35.5million to €103.9million. This was mainly the result of increases in short-term borrowings, part of financing activities in firms included in the Kering Group, Puma’s majority shareholder- holding over 75% of subscribed capital of PUMA SE (Puma SE, 2016). Such use of their credit facilities could be a direct result of Puma’s 2015 investment in ‘standardizing and optimizing the procedures between Puma and its external suppliers by restructuring the sourcing organization to manage global order and invoice flows.’ (Puma SE, 2016)
Another source of Puma’s liability increase is the increase in use of credit facilities. Puma has €401.7million of confirmed credit facilities, compared to €343.2million previously. Following the growth in total credit facilities, use of such facilities also increased. Unused credit facilities on December 31, 2015 totalled €306.0million, compared to €324.4million in the previous year (Puma SE, 2016). Adidas’s strategy employs using higher levels of liabilities than Puma, ensuring long-term liquidity through continued positive operating cash flows and sufficient financial flexibility through unused credit facilities (Adidas AG, 2016).
Adidas’s current accrued liabilities also contributed towards the total liability growth, mostly coming from an increase in customer discounts, invoices not yet received, marketing expenditure and personnel. Many of these increases can be attributed to their new strategic business plan: ‘Creating the New’ aimed at accelerating growth (Adidas AG, 2016).
The impacts of this ratio analysis help to compare the overall performance of the two companies and show that Adidas in many ways outperform Puma e.g. a superior return on equity. Analysis of strategies and ratios of the two firms enables more accurate and better judged forecasts for future performance.
FORECASTING
Puma AG
Sales growth
The global economy is expected to gain strength in 2016 and 2017, stimulating consumer consumption and sales. With improvements in product offerings, improved sourcing and higher marketing investments, PUMA is confident of sales growth in 2016 with initial profitability improvement (Puma SE, 2016). We predict net sales will increase at a high single-digit rate in 2016 and 2017. We also expect that expansion of retail stores and product launching will contribute to sales growth.
Net profit margin
We predict PUMA will experience an increase in net profit margin in both 2016 and 2017 due to the higher sales, though this will be slightly offset by increased operating expenses; two major sporting events in 2016 will require additional funding. Furthermore, additional investment is required to modernize current retail stores and ongoing investments into the upgrade of PUMA’s IT-infrastructure will contribute to increases in operating expenses (Puma SE, 2016).
Total asset turnover
PUMA’s planned investments for 2016 total €80million, mostly allocated to infrastructure investments necessary to help drive sustainable growth, as well as the expansion of the core markets and selective investments in retail stores (Puma SE, 2016). This indicates positive and stable investing efficiency. Sales are predicted to increase in the next two years, thus we have forecasted a slight increase for both years.
Total asset-to-equity ratio (leverage)
The Managing Directors and the Administrative Board have established long-term strategic priorities. PUMA’s management believes that the Forever Faster corporate strategy will lay the foundations for positive long-term development (Puma SE, 2016). We therefore expect the leverage ratio for 2016 and 2017 to remain the same as in 2015.
Pro forma financial statements: Puma
Fiscal Year*
(In € millions except % and X)
2015A
2016E
2017E
Sales growth rate (%)
14.0%
8.0%
6.0%
Sales
3,387.4
3,658.4
3,877.9
Net profit margin (%)
1.8%
2.2%
2.2%
Net profit
61.7
73.2
85.3
Total asset turnover (X)
1.3X
1.4X
1.4X
Total assets
2,620.3
2,613.1
2,769.9
Total assets-to-equity (X)
1.6X
1.6X
1.6X
Shareholders’ equity
1,619.3
1,633.2
1,731.2
* Fiscal year ends on 31 December
Adidas AG
Sales growth
The growing global economy will again play a factor, increasing demand. Consumption of sporting goods is on the rise, increasing sales revenue for companies like Adidas. Adidas hold sponsorship deals with UEFA and the Olympics, both scheduled to take place in 2016, boosting brand recognition. They will benefit from the Reebok brand by capturing the entire market at different disposable income levels. Using this, we predict that sales will increase by 11% on a currency neutral basis.
Net profit margin
With sales increasing at a rate of 11%, we would expect the cost of sales to rise but at slower rate. We therefore predict the net profit margin increase significantly through the next two years.
Total asset turnover
Assets will increase at a faster rate than sales as capital expenditure is undertaken, although this change will be reversed in the following years as sales in new markets increases. We therefore expect the turnover ratio to increase slightly to 1.4 for the following two years. There will also be significant increases in ecommerce in the next few years, though there may be some lag on the effects of these to be appreciated.
Total asset to equity ratio (leverage)
Positive long term development priorities have been established and matured, therefore the leverage ratio is expected to be constant with a slight rise in 2017. Adidas have an ongoing strategy of reducing gearing to low levels. With revenue increasing at a stable rate we forecast the asset-to-equity ratio to stay constant.
Pro forma financial statements: Adidas
Fiscal Year*
(In € millions except % and X)
2015A
2016E
2017E
Sales growth rate (%)
16.4%
11.0%
11.0%
Sales
16,915
18,775.7
20,934.8
Net profit margin (%)
3.8%
5%
6%
Net profit
640
938.8
1256.1
< br /> Total asset turnover (X)
1.3X
1.4X
1.4X
Total assets
13,343
13,411.2
14,953.4
Total assets-to-equity (X)
2.4X
2.4X
2.6X
Shareholders’ equity
5,666
5,666
5,666
* Fiscal year ends on 31 December
VALUATION
To determine the equity value per share we have used: Price/Book Ratio and Discount Abnormal Earnings.
The Price/Book ratio is easy for calculation and interpretation. ROE revealed the most about a firm’s financial and operating position from ratio analysis; firms with larger ROEs usually have increased P/B ratios. This is because ‘investors naturally bid up the price of a company that gives them a better return on their equity’ (Durell, 2005)
Adidas’s ROE was much larger than Puma’s, we assumed this would be reflected in their P/B ratios using the price multiple method. As comparable companies were used, rather than observed P/B ratios, this was not the case. Using these we obtained a Puma equity value of €369 per share.
The DAE method measures value creation, and isn’t easily affected by accounting changes as the Book Value and Abnormal Earnings both integrate accounting policies, and cancel out. Moreover, this method relates to published and forecasted figures making information more verifiable.
We have chosen 4% as a growth rate because we expect both book value and earnings per share to grow, however we expect earnings per share to grow at a higher rate (due to the forecasted sales increase). This produced a Puma equity value of €227.76 per share.
For Adidas P/B ratio was implemented, producing an equity value of €171 per share.
Using forecasted figures for Adidas we applied a 7.5% growth rate for the DAE, which reflects the expected increase in sales of 11.5%, producing an equity value of €177.58 per share.
We believe that DAE provides a more accurate forecast than the price/book ratio, as it doesn’t rely on industry averages which can skew results. We will use these value estimates as a guideline for our recommendation. For Puma, the current share price (March 31st 2016) is €194.05 (Hargreaves Lansdown, n.d.), which is 17% lower when compared with the equity value per share of €227.76. The share is currently undervalued and so it would be worth holding the shares as the share price can be expected to rise based on the forecast.
Adidas shares traded at €103 (March 31st 2016) (Hargreaves Lansdown, n.d.), while the equity value was €177.58. This means that Adidas are undervalued by 42%, therefore we recommend buying more shares, expecting gains when share prices converge towards equity values.
In conclusion, this analysis of accounting data has highlighted impacts of strategy on ratios, forecasting performance and equity valuation, however there are limitations. Forecasting is subjective as it is uses estimates for future unknown values. Whilst these are informed estimates there is room for volatility in these. Valuation can also be misleading as it is affected by accounting quality and choice of comparables.
Word Count: 3500
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Sportswear: Industry Background
Nike, Adidas and Puma are main players in the sportswear industry, holding 80% of the market share (Kissane, 2017). The sportswear industry was valued at US $78 billion in 2016 (Kissane, 2017), and the apparel and footwear market is rapidly expanding. The European and U.S. markets are booming, with Chinese markets continuing to develop. (Adidas AG, 2016) (Puma SE, 2016)
Puma AG
Puma designs, develops and sells footwear, apparel and accessories. Their products are distributed in 120+ countries and they employ 10,000+ people worldwide (Puma SE, 2016). Puma also collaborate with renowned design brands to bring innovative designs to the sporting world.
Strategies
Puma’s mission: ‘To be the Fastest Sports Brand in the world’ (Puma, n.d.a) is expressed through all its actions and decisions. Their strategy encompasses five strategic priorities: repositioning PUMA as the World’s Fastest Sports Brand; the improvement of their product engine, optimization of the distribution quality as well as increasing the speed within their organization and infrastructure, whilst renewing the IT infrastructure. (Puma, n.d.a) Recently Puma’s focus has been on developing their female customer base by introducing a women’s shoe and apparel collection in collaboration with Rihanna. (Puma SE, 2016)
Key Success Factors and Risks
Puma’s clearer design, innovative technology and product commerciality drive success, and frequent product launches, e.g. IGNITE (running technology), demonstrate continuous innovation (Puma SE, 2016).
Puma, a member of the Better Cotton Initiative, partners with bluesign technologies to use sustainable materials, building a greener brand (Puma, n.d.b).
Adidas AG
Adidas have delivered high quality products for over 80 years; they employ 55,000 people in 160+ countries, producing over 778 million products every year and generating sales of €17billion (Adidas AG, 2016). Adidas are dominant in similar markets to Puma.
Strategies
Adidas embrace a multi-brand strategy, focusing on 3 main areas: quickly satisfying consumer needs; expansion into different cities; focusing on high potential markets and channels, by inviting high profile individuals to be part of the brand (Adidas, n.d.a). They also focus on sustainability and creating a diverse brand portfolio (Adidas AG, 2016).
Key Success Factors and Risks
Strengths
Adidas operate in ‘2700 own-retail stores, 11,000 franchise stores, 116,000 wholesale doors and nearly 50 own e-commerce sites’, allowing efficient product distribution, and high availability through several channels (Adidas AG, 2016).
Adidas maintains customer relations through celebrity collaboration and sponsoring major sports organizations, e.g. FIFA, NBA and Olympics; thus building their brand and increasing their customer base. (Adidas AG, 2016) Constant innovation has enabled Adidas to continually improve, whilst helping the environment, e.g. using ocean plastics to create shoes (Adidas, n.d.b)
Risks
Although Adidas is a global brand, it faces fierce competition from other brands, e.g. Nike. There is potential for price wars between companies as they experience intense competition. As well as risks relating to organisational structure and change, a heavy reliance on outsourcing production leads to suppliers having more bargaining power than companies. Due to being a global company, it could potentially be affected by currency fluctuations, which could take a huge toll on product prices and profits. (Bhasin, 2016)
RATIO ANALYSIS
This section analyses Puma and Adidas on five key areas: profitability, operating efficiency, investing efficiency, liquidity, and solvency. Ratios are then used to compare firms and analyse trends, highlighting the strategic reasoning behind these figures.
Profitability
Return on Equity (ROE)
ROE indicates the money the company is making as a percentage of their equity. Puma had a low 2015 ROE of 3.8%. This was a significant fall of 1.4%, and well below the industry average of 10.4% for 2015 (Compustat, 2017). Puma’s 2015 net profit fell by 27.2%, causing a decrease in their ROE.
Meanwhile, Adidas saw an increase in their ROE to 11.3%. This increase in ROE could also be directly attributed to a change in their net profit, up by 29%.
Adidas repurchased treasury shares during 2015; despite this, total equity still increased. Repurchasing shares while the company is overperforming can help protect firms against future drops by having the ability to increase equity through resale, increasing shareholder value (Merritt, n.d.).
As Puma’s net profit margin decreased during 2015, they didn’t have this option. This may become an issue for them if they continue to see a drop in profit and their share price falls.
By decomposing ROE using the DuPont approach, we can assess the different factors that impact ROE:
ROE = Net Profit Margin x Total Asset Turnover x Financial Leverage
Using this formula, we can identify key performance drivers for Puma and Adidas.
For Puma, it is obvious that net profit margin hugely impacted their ROE. Despite two of the three drivers increasing- financial leverage and total asset turnover, ROE decreased. A further analysis of net profit margin can be seen below.
Comparatively, Adidas’s ROE increased, up by 28.2%. Again, we note net profit margin having the biggest impact on ROE. Adidas also experienced increases in financial leverage- rising to 235.5% from 220.8%. (Adidas AG, 2016) This increase is attributable to an increase in total assets- primarily non-current assets, e.g. PPE, Goodwill. PPE increased due to the acquisition of a warehouse in Russia, which they previously leased (Adidas AG, 2016). Goodwill value is mostly related to the acquisition of Reebok in 2006 and differs with the varying success of Reebok. (Adidas AG, 2016)
It is important to note the DuPont formulation doesn’t clearly separate operating components from financing. An ROOE breakdown is provided in the appendices, highlighting that Puma has a larger spread than Adidas. This is because Puma have negative levels of net financial liabilities in 2014, due to low levels of short term borrowing (Puma SE, 2016), however this figure has since become positive and this spread might be expected to decrease in future years.
Operating Efficiency
Net Profit Margin
Net profit margin is a measure of operating performance. Puma’s net profit margin in 2015 was 1.82%, this was a decline from the previous year’s margin of 2.85%- “unfavourable exchange rate effects had a negative impact on other operating income and expenses” (Puma SE, 2016). Puma is a global company operating in many different countries, meaning their financial performance is sensitive to exchange rate volatility. The USA is a major market, the strengthening of the dollar (Gillespie, 2015) suggests that, any expenses incurred in the U.S will be costlier than previously due to reporting in Euros. This is further proved by an increase in the cost of sales year on year from 2014 to 2015.
Adidas saw a slight increase in their net profit margin in 2015, up 0.37% to 3.78%. Like Puma, Adidas experienced increases in operating expenses attributed to higher losses from currency conversion, as they also report in Euros. However, Adidas also experienced increases in net sales due to an increase in royalty income from associated companies (Adidas AG, 2016). Adidas have many affiliated companies, such as TaylorM
ade, (Adidas AG, 2016) and have income from a wider product range than Puma. This suggests that Adidas are a more diversified company than Puma.
Investing Efficiency
Trade Receivables Turnover
Trade receivables turnover looks at how efficiently credit payments are collected. For Puma in 2015, this was 7.27, an increase of 6.8% on 2014. Adidas have a significantly higher receivables turnover ratio of 8.47- also an increase on the 2014 figure of 9.4%.
Puma attributed their rise in receivables turnover to a rise in fourth-quarter sales (Puma SE, 2016). We can assume that Adidas’s increase was also due to such an increase, as they also experienced an increase in sales during their fourth quarter. 30.5 % of Adidas’ new sales were made on credit- a driving factor of the increase in receivables turnover. The proportion of Adidas’ sales made on credit has decreased, so their receivables turnover will increase. Puma reflect this position as the value of Puma trade receivables as a percentage of net sales has also decreased.
In this regard the two companies are reasonably comparable. Despite Adidas being a significantly larger company than Puma, they don’t have an advantage in trade receivables collection efficiency. This may be linked to the similarity in customers, they operate in similar markets thus their potential customers may be matched. Therefore the collection of receivables for both companies may rely on customers with similar credit payment behaviours.
Trade Payables Turnover
Trade payables turnover calculates how many times during the fiscal period payables amounts are paid. For Puma, this was 3.57 in 2014 and 2015, showing the ability to control cash flow to settle payables. Though their turnover didn’t change, average payables increased by 75 million. Puma’s cost of sales increased (due to increased stock levels) proportionally with increases in trade payables. (Puma SE, 2016).
Adidas saw increases in trade payables turnover from 4.38 to 4.76 year-on-year. Cost of sales grew at a much larger rate than average payables; showing Adidas are settling their payables more often than previously. It could be argued that as Adidas are a much larger company, they would hold a higher level of supplier bargaining power and therefore have a lower figure, however, Adidas’s trade payables turnover is significantly larger than Puma’s. This suggests that Puma hold more successful negotiations with suppliers over payment terms.
Total Asset Turnover
The total asset turnover indicates how efficiently a firm employs its assets relative to revenue. Analysis of Puma’s and Adidas’s total asset turnover indicates Adidas deploy assets more efficiently when generating revenue. However, the total asset turnover for both firms has increased, primarily due to an increase in sales.
Puma have reported sales increases in every region, the largest in the America region (Puma SE, 2016). One explanation for this region’s 23% sales increase is a recent marketing strategy promoting Puma by Rhianna (Hegmann, 2016). Their largest source of sales was footwear, which ‘continued a sustained growth trend’. Puma CEO Bjørn Gulden noted significant progress in sports footwear and its growth potential (Hegmann, 2016). Puma also mentioned their ‘Forever Faster’ strategy (Puma SE, 2016), with increased focus on sports performance; this explains the significant growth in footwear and apparel. Puma experienced an increase in average total assets, though this was offset by the increased growth in sales.
Adidas’s total asset turnover also increased, from 1.21 to 1.31. Driven by sales growth, their sales increased by €2,381million, and average total assets also increased (Adidas AG, 2016). Adidas’s increase in assets were attributable to increases in receivables and non-current assets (Adidas AG, 2016). Like Puma, Adidas’s main source of sales growth was footwear with a large increase (23%) compared with other products (apparel increased by 11%, hardware fell) (Adidas AG, 2016).
Regionally, the Americas and Western Europe have a comparable level of sales in 2015, providing most sales revenues. A 20% increase in sales in Western Europe increased net sales for the group. This could be related to a push on sponsorship deals with major European sporting teams, such as Manchester United (Bourke, 2016). This contrasts with Puma, where Western Europe provides a decreased level of sales compared to America.
Liquidity
Current Ratio
This indicates an entity’s ability to meet obligations (short and long-term). A lower ratio shows a firm is less capable in paying its obligations. The retail industry, on average, has high current ratios. For example, Dun & Bradstreet approximated that the average current ratio for an apparel retailer is 1.9 (Guru, n.d.). Using 2015 data, Puma’s current ratio is 1.91, and Adidas’s is 1.4.
Both companies use AVCO when valuing inventory, helping comparability. Puma’s current ratio has decreased from 2 in 2014 to 1.91 in 2015; down 4.5%, due to a 6.6% increase in current liabilities, relative to a 1.2% increase in current assets. The latter was caused by a 127% increase in other current financial liabilities (primarily liabilties from market valuation of forward exchange transactions); offset by decreases in income taxes, other current provisions and financial liabilities.
Adidas’s ratio decreased from 1.7 to 1.4; a comparatively larger decrease of 17.6%. This was fuelled by a 22.5% increase in current liabilities, compared to a 2% increase in current assets (2014-2015). This increase in current liabilities was driven by a 56.5% increase in current financial liabilities due to increases in Sundry relating to purchase price obligations for non-controlling interests and a 34.9% increase in current accrued liabilities, including marketing distribution costs and costs relating to goods and services not yet invoiced.
The two companies had a large difference in short term financial assets. Adidas’s short-term financial assets make up 0.0667% of current assets; Puma’s are 4.56%. If Adidas had a similar level of short-term financial assets, relative to other levels of current assets, their ratio would converge towards the apparel retail average.
Quick Ratio
Inventory makes up a significant proportion of total current assets, greatly increasing the current ratio. The effect of removing inventory is shown when calculating the quick ratio. Using 2015 data, Puma’s quick ratio is 1.17 and Adidas’s is 0.82.
High levels of inventories are expected in the retail industry. However, excessive inventory levels can lead to increased waste and inefficiencies. The importance of achieving optimally low levels of inventory and tighter operating working capital is stressed in Adidas’s 2015 financial statement. Despite this, Adidas’s inventory levels increased by 23.3% due to higher stock levels required to support the Group’s top-line momentum, to ‘shorten order-to-delivery times and ensure availability of products’ (Adidas AG, 2016). Adidas plan to further reduce inventory levels by aiming to ‘bring production back to where the main markets are’ through making more goods in Europe rather than Asia (BBC, 2015). This is mirrored in Puma’s financial statements. Inventory levels increased by 15%, ‘in order to ensure product availability even when demand is strong and meet the increased need for products due to our new retail stores’ (Puma SE, 2016).
Solvency
Liabilities to Equity
This is influenced by changes in total liabilities and ordinary shareholder equity. Analysis of Adidas and Puma’s future obligations relative to equity, shows changes in this ratio were due to increases in total liabilities.
Increased liabilities
inflated the liabilities to equity ratio for both companies: Puma’s increased by 4.3%, Adidas’s by 14.9%.
Adidas implements a strategy with much higher leverage levels than Puma; there are risks and advantages to both strategies. Lower leverage is less risky for the firm but forgoes shareholder returns. This is reflected in Adidas’s annual report: ‘we are committed to increasing returns to shareholders with above-industry-average share price performance and dividends.’ (Adidas AG, 2016). Puma’s increase in liabilities is substantial, despite being lower than Adidas’s and was due to an increase in other current liabilities; increasing from €35.5million to €103.9million. This was mainly the result of increases in short-term borrowings, part of financing activities in firms included in the Kering Group, Puma’s majority shareholder- holding over 75% of subscribed capital of PUMA SE (Puma SE, 2016). Such use of their credit facilities could be a direct result of Puma’s 2015 investment in ‘standardizing and optimizing the procedures between Puma and its external suppliers by restructuring the sourcing organization to manage global order and invoice flows.’ (Puma SE, 2016)
Another source of Puma’s liability increase is the increase in use of credit facilities. Puma has €401.7million of confirmed credit facilities, compared to €343.2million previously. Following the growth in total credit facilities, use of such facilities also increased. Unused credit facilities on December 31, 2015 totalled €306.0million, compared to €324.4million in the previous year (Puma SE, 2016). Adidas’s strategy employs using higher levels of liabilities than Puma, ensuring long-term liquidity through continued positive operating cash flows and sufficient financial flexibility through unused credit facilities (Adidas AG, 2016).
Adidas’s current accrued liabilities also contributed towards the total liability growth, mostly coming from an increase in customer discounts, invoices not yet received, marketing expenditure and personnel. Many of these increases can be attributed to their new strategic business plan: ‘Creating the New’ aimed at accelerating growth (Adidas AG, 2016).
The impacts of this ratio analysis help to compare the overall performance of the two companies and show that Adidas in many ways outperform Puma e.g. a superior return on equity. Analysis of strategies and ratios of the two firms enables more accurate and better judged forecasts for future performance.
FORECASTING
Puma AG
Sales growth
The global economy is expected to gain strength in 2016 and 2017, stimulating consumer consumption and sales. With improvements in product offerings, improved sourcing and higher marketing investments, PUMA is confident of sales growth in 2016 with initial profitability improvement (Puma SE, 2016). We predict net sales will increase at a high single-digit rate in 2016 and 2017. We also expect that expansion of retail stores and product launching will contribute to sales growth.
Net profit margin
We predict PUMA will experience an increase in net profit margin in both 2016 and 2017 due to the higher sales, though this will be slightly offset by increased operating expenses; two major sporting events in 2016 will require additional funding. Furthermore, additional investment is required to modernize current retail stores and ongoing investments into the upgrade of PUMA’s IT-infrastructure will contribute to increases in operating expenses (Puma SE, 2016).
Total asset turnover
PUMA’s planned investments for 2016 total €80million, mostly allocated to infrastructure investments necessary to help drive sustainable growth, as well as the expansion of the core markets and selective investments in retail stores (Puma SE, 2016). This indicates positive and stable investing efficiency. Sales are predicted to increase in the next two years, thus we have forecasted a slight increase for both years.
Total asset-to-equity ratio (leverage)
The Managing Directors and the Administrative Board have established long-term strategic priorities. PUMA’s management believes that the Forever Faster corporate strategy will lay the foundations for positive long-term development (Puma SE, 2016). We therefore expect the leverage ratio for 2016 and 2017 to remain the same as in 2015.
Pro forma financial statements: Puma
Fiscal Year*
(In € millions except % and X)
2015A
2016E
2017E
Sales growth rate (%)
14.0%
8.0%
6.0%
Sales
3,387.4
3,658.4
3,877.9
Net profit margin (%)
1.8%
2.2%
2.2%
Net profit
61.7
73.2
85.3
Total asset turnover (X)
1.3X
1.4X
1.4X
Total assets
2,620.3
2,613.1
2,769.9
Total assets-to-equity (X)
1.6X
1.6X
1.6X
Shareholders’ equity
1,619.3
1,633.2
1,731.2
* Fiscal year ends on 31 December
Adidas AG
Sales growth
The growing global economy will again play a factor, increasing demand. Consumption of sporting goods is on the rise, increasing sales revenue for companies like Adidas. Adidas hold sponsorship deals with UEFA and the Olympics, both scheduled to take place in 2016, boosting brand recognition. They will benefit from the Reebok brand by capturing the entire market at different disposable income levels. Using this, we predict that sales will increase by 11% on a currency neutral basis.
Net profit margin
With sales increasing at a rate of 11%, we would expect the cost of sales to rise but at slower rate. We therefore predict the net profit margin increase significantly through the next two years.
Total asset turnover
Assets will increase at a faster rate than sales as capital expenditure is undertaken, although this change will be reversed in the following years as sales in new markets increases. We therefore expect the turnover ratio to increase slightly to 1.4 for the following two years. There will also be significant increases in ecommerce in the next few years, though there may be some lag on the effects of these to be appreciated.
Total asset to equity ratio (leverage)
Positive long term development priorities have been established and matured, therefore the leverage ratio is expected to be constant with a slight rise in 2017. Adidas have an ongoing strategy of reducing gearing to low levels. With revenue increasing at a stable rate we forecast the asset-to-equity ratio to stay constant.
Pro forma financial statements: Adidas
Fiscal Year*
(In € millions except % and X)
2015A
2016E
2017E
Sales growth rate (%)
16.4%
11.0%
11.0%
Sales
16,915
18,775.7
20,934.8
Net profit margin (%)
3.8%
5%
6%
Net profit
640
938.8
1256.1
< br /> Total asset turnover (X)
1.3X
1.4X
1.4X
Total assets
13,343
13,411.2
14,953.4
Total assets-to-equity (X)
2.4X
2.4X
2.6X
Shareholders’ equity
5,666
5,666
5,666
* Fiscal year ends on 31 December
VALUATION
To determine the equity value per share we have used: Price/Book Ratio and Discount Abnormal Earnings.
The Price/Book ratio is easy for calculation and interpretation. ROE revealed the most about a firm’s financial and operating position from ratio analysis; firms with larger ROEs usually have increased P/B ratios. This is because ‘investors naturally bid up the price of a company that gives them a better return on their equity’ (Durell, 2005)
Adidas’s ROE was much larger than Puma’s, we assumed this would be reflected in their P/B ratios using the price multiple method. As comparable companies were used, rather than observed P/B ratios, this was not the case. Using these we obtained a Puma equity value of €369 per share.
The DAE method measures value creation, and isn’t easily affected by accounting changes as the Book Value and Abnormal Earnings both integrate accounting policies, and cancel out. Moreover, this method relates to published and forecasted figures making information more verifiable.
We have chosen 4% as a growth rate because we expect both book value and earnings per share to grow, however we expect earnings per share to grow at a higher rate (due to the forecasted sales increase). This produced a Puma equity value of €227.76 per share.
For Adidas P/B ratio was implemented, producing an equity value of €171 per share.
Using forecasted figures for Adidas we applied a 7.5% growth rate for the DAE, which reflects the expected increase in sales of 11.5%, producing an equity value of €177.58 per share.
We believe that DAE provides a more accurate forecast than the price/book ratio, as it doesn’t rely on industry averages which can skew results. We will use these value estimates as a guideline for our recommendation. For Puma, the current share price (March 31st 2016) is €194.05 (Hargreaves Lansdown, n.d.), which is 17% lower when compared with the equity value per share of €227.76. The share is currently undervalued and so it would be worth holding the shares as the share price can be expected to rise based on the forecast.
Adidas shares traded at €103 (March 31st 2016) (Hargreaves Lansdown, n.d.), while the equity value was €177.58. This means that Adidas are undervalued by 42%, therefore we recommend buying more shares, expecting gains when share prices converge towards equity values.
In conclusion, this analysis of accounting data has highlighted impacts of strategy on ratios, forecasting performance and equity valuation, however there are limitations. Forecasting is subjective as it is uses estimates for future unknown values. Whilst these are informed estimates there is room for volatility in these. Valuation can also be misleading as it is affected by accounting quality and choice of comparables.
Word Count: 3500
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