Coronavirus: A market perspective May 7th 2020


By: Mark Nelson

An industry perspective: the history of the sportswear sector and its post-coronavirus outlook

We have written many times over the last several years of how we seek to avoid trying to time equity markets or attempting to call short-term price action, preferring instead to consider long-term themes and finding high quality businesses that play to them.

With that in mind, this week we take a close look at one particular industry, sportswear, and discuss its structure, its growth prospects, how it might be impacted by the coronavirus crisis, and then consider the companies that operate within this sector, focusing on one in particular which we believe meets our investment requirements.

The sportswear industry consists of companies whose principal activity is selling athletic footwear, clothing and / or equipment to customers around the world. Its roots can be traced back to the 19th century to a few businesses that began to develop sports shoes.

In the UK, a cobbler named Samuel Foster had developed a set of spiked shoes for cricketers of Nottinghamshire County Cricket Club. His grandson, a keen amateur runner named Joseph William Foster, took an interest in the shoes. He altered them into a set of ‘running pumps’ before creating a company, J.W. Foster & Sons. This company went on to provide the running spikes for Eric Liddell and Harold Abrahams, whose gold medals in the 1924 Paris Olympics would be the basis for the 1981 film Chariots of Fire. Joseph Foster’s grandsons would go on to found Reebok in 1958.

Across the Atlantic, the United States Rubber Company, one of the original 12 stocks in the Dow Jones Industrial Average, began producing shoes with rubber soles aimed at participants in lawn sports. This gave birth to the tennis shoe or, if you prefer, the sneaker, as the rubber sole made considerably less noise than its predecessors, allowing the wearer to, in theory, sneak up on somebody.

Fast forward through the next hundred or so years and we have seen, among several others, two feuding German brothers set up rival sportswear businesses (Adidas and Puma), a former Japanese military officer start an athletic shoe business as a means of inspiring the youth of Japan following the Second World War (Onitsuka Tiger or ASICS as it is known today), and a young runner from Oregon, whose company had initially been the US distributor for Onitsuka Tiger, decide to go it alone with a brand name inspired by Greek mythology (NIKE).

These companies, and others, have supported some of the greatest feats of sporting endeavour, from Liddell and Abrahams in 1924 to Eliud Kipchoge’s sub-two-hour marathon nearly a century later.

The proliferation in sportswear companies has coincided with growth in sportswear spending by consumers, which has increased its share of the overall apparel and footwear market. This has been supported over several decades by the increasingly high profile of sports and the growth in the broadcasting and marketing of it. More recent drivers include an increased focus on healthy living, the rising middle class in emerging economies, and the increasingly informal nature, or casualisation, of fashion , due, in part, to the popularity of streetwear and ‘athleisure’ (athletic leisure) clothing.

Competition within the sector is intense, with companies battling for market share through the marketing, quality, style, newness and price of their products, and through creating consumer connections and affinity for their brand(s). Some aim to serve the entire market, including the two biggest brands by revenue, NIKE and adidas, while others operate in relative niches such as ASICS, which is known for its performance footwear, and lululemon athletica, whose brand is built around its yoga pants.

The level of competition has translated into a variability in both the financial and share price performance of the listed names that operate in the space. Looking at the five years of financial data from immediately before the coronavirus outbreak, gross margins are relatively similar across the sector, ranging from the mid-40% level to the low-50%, but operating margins have ranged from low single digit percentages to as high as 20%. Returns on capital employed, an important metric for investors which provides an indication of the value created by a business with the capital available to it, also vary significantly.

This variability in performance has continued during the coronavirus outbreak, with the shares in those companies with the strongest balance sheets outperforming those with relatively higher levels of leverage. For example, shares in lululemon, a company that had a net cash position going into the crisis, are down just 6% year-to-date. In contrast, Under Armour, which is relatively highly leveraged and whose bonds are rated at sub-investment grade by major rating agencies, has seen its shares more than half in value since the start of the year.

Going into the coronavirus crisis, there had been questions as to whether the growth in sportswear spending relative to the overall apparel and footwear market could continue. Our view was that it would, as while penetration in geographies such as North America is high, it remains low in many others, including large emerging economies such as China, where sports participation is on the increase.

We now believe that the sector may find long-term support from the crisis, as the public’s focus on individual health is intensified by the outbreak, and as exercise – one of the few freedoms that many societies have had during periods of lockdown – becomes more popular. We also believe that the casualisation of fashion and the growth in athleisure may be extended by a structural increase in people working from home.

Our favoured way to invest in the sportswear industry is through the shares of Nike. It is the world’s largest sportswear company which sells its products through Nike-owned retail stores and digital platforms, and to major retail chains and independent distributors. It is focused on six key categories; Running; Nike Basketball; the Jordan Brand; Football (Soccer); Training; and Sportswear.

The company fits the description of a high-quality business with a strong track record in value creation as measured by elevated returns on capital employed and returns on invested capital. High relative returns can indicate the presence of a competitive advantage for a company, and the question is then whether it is able to defend that advantage and its strong returns relative to the rest of its industry.

Sustainable competitive advantages can often come from a combination of two very important characteristics, a strong brand and scale. Nike has both. The NIKE brand was ranked as the 16th most valuable brand in the world in 2019 by Interbrand, one of only two sportswear brands that made the top 100, and valued roughly three times that of the adidas brand.

Its scale meanwhile is demonstrated by the size of its revenues, which, over the last 12-months, were 1.7x that of those of adidas. Its cash flows are also significantly higher than its peer group, with its free cash flow over the last 12-months greater than all the other brands mentioned in this piece combined.

Scale can allow for greater relative reinvestment back into a business in order to maintain a brand’s desirability and relevance, something which Nike is a master at, supporting its brand equity through several channels. First, it does it through its partnerships with an unparalleled roster of the world’s leading athletes and sports teams.

Second, it does it through technical innovation which is used to improve the performance of its products but also the desirability of its brand. The controversial Vaporfly Next Percent running shoe is a great example of this. We don’t believe that Nike anticipates these £240 trainers being a key driver of revenues, but the coverage they have received, and the results achieved by athletes that have worn them, keep the brand front-of-mind and reinforce the strength of Nike products and the company’s technical know-how.

The third way in which Nike invests to support its brand is through its well-developed digital strategy, which includes and its ecosystem of training applications. These apps do things such as track runs or provide users with a variety of workouts that can be done at home.

This digital strategy seemingly has come to the fore during the ongoing coronavirus outbreak. In its third quarter results released at the end of March, Nike reported that in China, as the country went into lockdown, it moved to leverage its digital application ecosystem. As a result, the Nike Training Club workouts experienced “an extraordinary rise in sign up and engagement” and weekly active users across all of its activity apps increased 80% by the end of the third quarter versus the beginning of the year. This resulted in a greater than 30% increase in digital sales in the Greater China region, helping to partially offset the impact of store closures. Remarkably, once stores began to reopen in the country, its digital sales accelerated even further, demonstrating the power that these consumer connections can have.

Overall, while in the short term the coronavirus outbreak will have a negative impact on sportswear spending due to physical store closures, we continue to believe in the long-term drivers of growth in the sector, some of which may find support from the crisis. We view Nike as well placed to navigate the current environment, due to the strength of its balance sheet and its digital expertise, perhaps even gaining market share due to the relative struggles of others. Looking further ahead, we expect the strength of the NIKE brand, and the company’s ability to invest in order to support this most valuable of assets, to help underpin returns for the company and in turn shareholders over the medium to long term.


Should you have any questions about anything raised in this article, please don’t hesitate to contact us via email, or on 0207 337 0777.

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This note has been produced by Killik & Co on the basis of publicly available information, and all sources are believed to be reliable, but we have not independently verified such information and we do not give any warranty as to its accuracy. Some of the stocks mentioned in this note are covered by Killik & Co’s Equity Research team and others are not. The mentioning of the stocks does not represent a recommendation to buy or sell any securities, and the note is intended as a marketing communication rather than research. This note does not purport to be a complete description of the securities, markets or developments referred to in the material. All expressions of opinion are subject to change without notice. Nothing in this note should be construed as investment advice or as comment on the suitability of any investment or investment service. Prospective investors should take advice from a professional adviser before making any investment decisions. There are risks with almost every investment that you may not get back the original capital invested. The value of your investments may fall as well as rise and the past performance of investments is not a guide to future performance.