Buy These Athletic Footwear Companies

Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Athletic-wear companies had a strong recovery from the Great Recession, with growing markets like running providing new revenue streams for firms to tap as they appeal to the global consumer. The two biggest athletic footwear companies in the world, Nike (NYSE: NKE) and Adidas (NASDAQOTH: ADDYY), are in a long-term struggle for dominance internationally. Under Armour (NYSE: UA) may be a dark horse contender, given its growth prospects.

I view Nike as the safest investment, with Under Armour an excellent secondary investment. I think Adidas is worth a look as well, but I am less confident in its ability to provide investors with great returns.

Established market leader

Nike has a series of strong, established brands, and its financials reflect the company’s position in leadership of the global market. The company delivered $2.4 billion of free cash flow and EPS of $2.69 in FY 2013 (Nike’s FY 2013 ran through May; the company has just begun FY 2014). The FY 2013 EPS reflects a roughly 11% spike in earnings and continues a trend of steady EPS growth since FY 2009’s low of $1.54.

Mixed news on revenue

Revenue grew 18% last quarter for North America, which drove Nike’s 9% revenue growth for fourth quarter 2013. Western Europe reported an 8% gain, while revenue from Eastern Europe grew by 13%.

The Japan and China segments reported revenue declines of 6% and 10%, respectively. While it’s great to see Nike growing revenue in North America (and in Europe, despite the continuing economic malaise), those markets are comparably saturated. The American and European economies also don’t have the growth potential of China – growth potential that will drive revenue for whatever company can harness mass appeal.

Critical investments

Under Armour reported a first quarter 2013 revenue increase of 23% year-over-year, with gross margin expanding slightly to 45.9%. The EPS fell to $0.07 from $0.14 year-over-year, due to a combination of a higher tax rate (just shy of 40%) and SG&A costs (primarily driven by higher spending in product innovation and marketing).

Normally, I would view an EPS decline combined with a revenue increase as a very bad sign – the company is bringing in more money but profiting less from it – but the increased spending involves investments critical to the firm’s future. In branded sportswear, brand is the reason people pay a premium for Under Armour – and product innovation will keep the company on the cutting edge. Management has shown the discipline and vision to sacrifice short-term profitability for a longer-term outlook, and, with very little debt on its books, the company can afford that trade-off.

Strengthening the brand

Management is making smart investments in the future with the Under Armour brand “holidays,” which feature a strong push for Under Armour apparel during three days of the year. These days will be when Under Armour’s “brand voice is bigger and louder than in any other part of the year,” according to CEO Ken Plank. The “I Will” campaign emphasizes Under Armour’s technological focus and is the largest (and first global) media buy in the company’s history. These are the sorts of moves that the company needs to make to keep building its brand and market share worldwide.

A long runway for growth

Unlike Nike, which must expand outside the US (it currently has over half of the US’ footwear market share), Under Armour has lots of room for growth, with a little under 2% of market share. Given that Under Armour is relatively new – and has consistently grown its market share in each of the last three years – I’m a lot more bullish on its chances for growth in the US compared to Adidas, which has 4.4% of US market share but hasn’t shown the same kind of sustained growth in the US.

A good first quarter

Adidas reported a revenue increase of 1% for first quarter 2013, with double-digit gains in Latin America (12%), solid single-digit growth in China (6%) and North America (3%), and declines in Western Europe (6% - primarily due to losses in Southern Europe) and other Asian markets (4%). Reebok improved its margins, and most of the individual product lines (basketball, outdoor, and the like) saw sales increases.

The running market

Adidas is branded well as a European sports shoe, but it has struggled more in the running category compared to Nike. Given that running is a $15-billion market with strong growth (13% in 2011), that’s where Adidas needs to focus its efforts – and that is precisely what management is doing.  Running revenue increased 12% for first quarter 2013, due in large part to the new Energy Boost brand – which won a number of awards and which management clearly views as a game changer. Initial reviews are very positive.

Valuation

For Under Armour, the P/E for the trailing-12 months is a very pricey 53.8, and even on a forward basis the ratio is 33.9 – this is not a cheap stock. Given its growth prospects, these numbers seem about right, although the stock is currently a bit too expensive for me. Adidas sits at a P/E of 32.7 for the trailing-12 months, with a forward P/E of 5.8 per Morningstar. Nike’s P/E ratio is 24.7 for the trailing-12 months and 18.2 on a forward basis.

Foolish conclusion

All three of these companies are worth an investment, based on your investing style and thesis. Under Armour has the best growth prospects, and an aggressive investor with a long-term focus will accept the high valuation for the expected long-term return. Nike is another great long-term hold, with an entrenched position and plenty of cash to fund marketing and innovation.

With Adidas, the major question is whether the Energy Boost is as big of a game changer as management believes it to be. If it represents a significant breakthrough, then sales of the shoes will continue skyrocketing and the company has tremendous growth prospects as it moves into the running market. If not, the company is still in good shape – but with lesser growth prospects than Under Armour and a position less entrenched than Nike. Personally, my money’s on Nike for the long haul – it’s the safest of the three.

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Michael Douglass has no position in any stocks mentioned. The Motley Fool recommends Nike and Under Armour. The Motley Fool owns shares of Nike and Under Armour. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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