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Rising Sourcing Costs to Drive Down Adidas’ Margins in the Second Half

Thanks to a combination of sky-high expectations and ongoing supply chain issues, Adidas’ second-quarter financial results were received poorly on Wall Street Thursday morning, sending its share price down nearly 3.5 percent to $149.75 at publication time.

In a Nutshell: Adidas was able to keep to its outlook in the second quarter, with strong net income and revenue growth at both its namesake brand and Reebok. However, its financial report revealed continued supply chain shortfalls keeping it from delivering on increased demand—which the brand acknowledged in March—constraining its profits over the first half of the year.

“We are flying in products from Asia to make certain we can actually satisfy demand, which has been the constraining factor this quarter,” Adidas CEO Kasper Worsted told Bloomberg Thursday.

Rorsted’s prediction of increased air freight costs and a “less-favorable pricing mix” led to Adidas warning investors of a gross margin decline over the second half, though the brand said much of this impact would be offset by a mid-digit increase in revenue and a double-digit increase in net income.

In either case, Adidas was proactive in keeping top-line growth ahead of shrinking margins in Q2, growing its marketing and point-of-sale expenses by 5 percent to total $744 million during the quarter—primarily due to increased brand investment.

Sales: Second-quarter revenue at Adidas was up 5 percent over the comparable period to 5.509 billion euros ($6.17 billion), led by a 4 percent increase in “Sport Inspired” sales. Reebok returned to growth in the quarter after turning in a few disappointing quarters, with sales up 3 percent on the strength of its Classics category.

Revenue in North America was up 6 percent, representing 5 percent growth for Adidas and a 10 percent jump for Reebok. Latin America revenues followed suit at 5 percent growth while sales in Europe were flat. Meanwhile, revenue in Russia fell 4 percent due to the prior year comparison occurring during the nation’s hosting of the 2018 FIFA World Cup.

Emerging markets were decidedly positive for the brand, registering growth of 12 percent in the second quarter. The Asia-Pacific region, which currently makes up close to a quarter of the brand’s sales, grew by 8 percent, driven primarily driven by a 14 percent leap in revenue from China.

All told, Adidas said its overall top-line growth was powered by a 37 percent increase in e-commerce and direct-to-consumer business.

Adidas kept to its outlook of mid-digit revenue growth for FY19 and says that it expects sequential acceleration through the end of the year.

Earnings: Adidas’ bottom-line growth was its best result, by far, in the second quarter. Net income from operations grew by 14 percent to 1.093 billion euros ($1.23 billion). This bumped its earnings per share 17 percent to 5.50 euros ($6.16).

Along with the brand’s top-line growth, Adidas expects the positive streak to continue for its net income over the last half of the year. Based on this quarter’s growth, it continues to project a 10 percent to 14 percent increase in net income for FY19.

CEO’s Take: Off the big stage, Rorsted said the brand turned in positive results—despite the supply chain challenges and industry headwinds it encountered throughout the quarter.

“We delivered another successful quarter. Sales in our strategic growth areas Greater China and e-commerce continued to increase at a double-digit rate—and so did our bottom line,” Rorsted said in a statement. “We remain confident about the sequential revenue acceleration in the second half of the year and confirm our top- and bottom-line outlook for 2019.”

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