The footwear industry has been a tough one to invest in over the past year. The bankruptcy of Sports Authority flooded the saturated U.S. market with excess inventory, which squeezed many shoemakers' gross margins as marketing costs rose.
This pressure hurt industry bellwether Nike (NYSE:NKE), which saw its stock rise just 1% over the past 12 months. It also torpedoed industry darling Under Armour (NYSE:UAA) (NYSE:UA), which lost over 40% of its market value during that period. Finish Line's disastrous first quarter report in late June simply validated the bearish thesis against the industry.
In the past, German footwear giant Adidas struggled with uninspired products, weak marketing campaigns, and its money-draining acquisition of Reebok. But in 2015, it launched an ambitious five-year turnaround plan which called for a faster rotation of its products, expansions into high-growth urban markets, higher e-commerce investments, and new engagement campaigns with customers, retailers, and partners.
Giving brand managers more power over the design and development of products and partnering with celebrities like Kanye West (who launched Adidas' popular Yeezy shoes) breathed fresh life into the 67-year-old brand. That's why Adidas' revenue rose 18% on a constant currency basis last year, while its net income surged 41%.
Adidas expects its revenue to rise 11%-13% on a constant currency basis this year, fueled by double-digit growth in Western Europe, North America, and China. It also expects its net income from continuing operations to grow 18%-20%.
Much of Adidas' growth seemingly comes at the expense of Under Armour, which generates most of its revenue from North America. Last quarter, Adidas' North American revenue surged 36% annually (31% on a constant currency basis), while Under Armour's North American sales fell 1%.
Adidas' main weakness is its valuation. The stock's 40% rally over the past 12 months boosted its P/E to 31, which is much higher than the industry average P/E of 21 for footwear makers. Nonetheless, investors seem willing to pay that premium, since Adidas has brighter growth prospects than many of its industry peers.
Last October, I compared Skechers to Nike and concluded that Skechers' lower valuation and overseas growth made it the better buy. Since that article was published, Skechers stock has rallied 26%, while Nike shares have risen just 2%.
That rally was fueled by Skechers' rapid overseas growth offsetting its weaker domestic growth. Its revenue rose 10% annually to $1.07 billion last quarter (the first time it topped $1 billion in quarterly revenues), fueled by 17% sales growth in its international wholesale business and 13% sales growth in its company-owned retail businesses.
Its comparable store sales rose 2.9% at its retail locations -- an impressive figure relative to the industrywide slowdown in brick-and-mortar traffic. All that growth easily offset its flat domestic wholesale revenue growth during the quarter. For the full year, analysts expect Skechers' revenue to rise 12% to $3.97 billion.
On the bottom line, Skechers' earnings remain under pressure, mainly due to currency headwinds. Its diluted EPS fell 5% annually last quarter, but analysts expect its full-year earnings to rise 13% as its top line growth offsets some of those currency impacts. Unlike Nike, Under Armour, and Adidas, Skechers doesn't rely heavily on big celebrity endorsements. That's why its sales and marketing expenses only claimed 7.5% of its revenue over the past 12 months.
As for its valuation, Skechers trades at 19 times earnings, which is lower than Adidas' P/E and the industry average -- so it could still have room to run.
The key takeaway
I believe that Adidas and Skechers are currently the best plays in footwear, but investors should be mindful of the risks. Adidas isn't cheap, and its growth is decelerating from the previous year. If it can't regain its momentum, the stock could stumble. Skechers looks like a solid play, but there's always the risk that bigger rivals like Nike, Adidas, and Under Armour could still hurt it with big marketing blitzes. Investors should weigh these risks against the potential rewards before buying either stock.