Consumer

Andrea Felsted is a Bloomberg Gadfly columnist covering the consumer and retail industries. She previously worked at the Financial Times.

So Kanye West wants to work with Ikea. The Swedish furnishing store hasn't jumped at the offer so far. But judging by the performance of Adidas, which already collaborates with the rapper, perhaps it should.

Adidas has got its groove back, after years of losing share to Nike and battling nimbler upstarts such as Under Armour. On Thursday, it reported a massive 26 percent rise in North American sales in the second quarter, building on last week's boost to its full-year sales and profit guidance.

Of course, Kanye isn’t solely responsible for the success. But the collaboration has lifted Adidas's profile, particularly in Nike's U.S. backyard. It's also helpful that Adidas's classic trainers, such as the Stan Smith, are enjoying a fashion moment, beloved of millennials on both sides of the Atlantic.

Catching up with the profitability of Nike and Under Armour has been a key strategic goal. Adidas has made improvement, but has a long way to go. 

Running to Catch Up
Adidas has started to close the gap on Nike's operating margin, but still has further to go
Source: Bloomberg

The company has taken the helpful step of becoming more like a fast-fashion retailer, as Gadfly has urged, and is cutting lead times on more products to just a few months, from the traditional 12-18 months. That raises its potential to boost margins further, as that will help it get more of its best sellers into stores, and quickly ditch lines that aren’t so popular. 

Adidas also plans to deepen its ties with West, who will lend his name to athletic shoes, clothes and accessories, plus a line of stores. That's part of a trend for sports brands to target high-profile individual stars, rather than entire teams -- though Nike's announcement yesterday that it will stop selling golf equipment, years after Tiger Woods' star flamed out, shows the perils of these links.

Adidas has long traded at a discount to Nike, but that trend reversed earlier this year. The company has done a lot right, and it deserved to have a big boost to its shares, which hit an all-time high on Wednesday. 

The Kanye Boost
Adidas shares look fully valued now that its no longer the underdog to Nike
Source: Bloomberg

 

However, the share price is factoring in a continuation of the current strong performance -- and more. The close to 30 percent premium to Nike looks hard to justify, particularly given that, even after the latest guidance, Adidas's operating margin is still only around half of Nike's. 

The strategic initiatives are welcome, but they will take time to lift Adidas's performance up another notch -- and that's needed given the punchy premium to Nike. Becoming more like a fashion retailer raises its own risks. Being in vogue has driven demand for its trainers. But fashion is notoriously fickle, and if it were to lose its edge, then it could be left with unsold stock, which it would have to sell at a discount, damaging profits. That looks far off for now, but with such a high valuation, it can't afford any style slip ups.

And the company has improved considerably since its announcement in January that Henkel's Kasper Rorsted would become chief executive. He arrives on Oct. 1, and may find that it's harder to make far-reaching changes -- such as a decision on whether to sell Reebok -- at a successful company than at at a poorly performing one.

Already there are some less positive signs. Inventories, excluding the effect of currency movements, rose 24 percent at June 30, compared with the year earlier. Adidas says this is to keep up with the high level of demand, but it is a worrying sign as it seems like a significant increase. 

The market's pricing in that this great performance will continue, and that's not guaranteed. For now, the shares look as pricey as a pair of Kanye West's Yeezy trainers.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Andrea Felsted in London at afelsted@bloomberg.net

To contact the editor responsible for this story:
Jennifer Ryan at jryan13@bloomberg.net