Motley Fool Hidden Gems Investing - An Inflection Point for adidas

Episode Date: June 13, 2023

Inflation is slowing down. Is this what a soft landing looks like? (00:21) Motley Fool Senior Analyst Asit Sharma and Ricky Mulvey discuss: - Big macro takeaways from the latest inflation numbers. - How adidas is dealing with the fallout from discontinuing its Yeezy line. - If the apparel maker has balance sheet risk. Plus, (15:00) Alison Southwick and Robert Brokamp discuss the costs and benefits of working with a financial advisor.  Companies discussed: ADDYY, NKE Article discussed: https://www.bloomberg.com/news/features/2023-05-25/adidas-s-yeezy-mess-has-been-a-billion-dollar-nightmare-for-the-business    Host: Ricky Mulvey  Guests: Asit Sharma, Robert Brokamp, Alison Southwick  Engineers: Dan Boyd, Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

Chris Hill Here's what happens when a company ties about half of its profits to someone who doesn't actually work there. You're listening to Motley Fool Money. Joining us now is Asit Sharma. Asit, we've got some fresh inflation numbers to dig into. Good to see you as always and then we'll dig into those. Same here. Nothing better than fresh numbers to work with. Headline inflation for the month of May hit a skosh over 4%. If you take out that pesky food and energy costs, you're at about 5.2%. Asit, is this what a soft landing feels like?

Well, Ricky, it could be. I think there are a few things I'd like to see fall in place before I would feel more confident in saying we're going to have a soft landing. Big picture, a year ago, the CPI number was at 9.1%. That was beginning of June of 2022. We're down five percentage points from that peak on the reported number. I see having to fall in place for this to feel not hard. The Fed will moderate further rate hikes. Maybe they hold the line this month and they don't obsess over this last two percentage points that's left between 4% where we are today and that long-term inflation rate they seek to hold, which is 2%. They've got to be patient. Number two, animal spirits. John Maynard Keynes developed this concept. It's

the feeling of confidence, the feeling of a good emotional state. That has to stick around in the economy. We're seeing it right now. People don't feel like we're in a recession. Yes, we all feel how difficult this inflationary period has been. But it doesn't feel like we're in a recession. So while consumers continue to spend, while businesses continue to spend, that's got to hold up. And just number three, corporations, they've done pretty well on profit management. If you look at the first quarter, S&P 500 profits, they didn't stink. They weren't through the roof, Ricky. But all in all, I think that the pullback in spends we saw, big tech in particular, other parts of the economy in the manufacturing side, this really helped the first quarter from

being a disaster. It's part of the reason why the market is continuing to rise, part of the reason why animal spirits are still high. Corporations are going to need to manage those profits into the second quarter and show a little bit of growth again. Yeah. It seems like there might be a little less inflation if shelter, the costs of housing and apartments continue the way that they are. This month, it showed that that cost was up 8% from a year prior, but there is some data coming in that housing prices, for instance, took a haircut in April. Apartment supply is growing as more new apartments come online. There might be a softening there that I hope the Fed is paying attention to,

I'm sure they are. Totally. Asit, let's say you're Jerome Powell, and you can look at three of these things, wage inflation, housing in the rental market, or regional banks. What are you paying the most attention to right now? Ricky, they're all great things to watch. I think it's still wage inflation. I think the regional bank story, while it's not one that's quite out of the woods yet, has stabilized. The Fed is watching it, but it's not as urgent as it was in March. Housing, rental, you were talking about these pressures just now. I think those indicators do lag a bit.

The Fed understands that more recent numbers indicate a little bit of cooling there. What you're worried about is a strong job market because that is the part of this whole puzzle that could really push inflation forward again. If that demand continues to go up, labor is tight. It's what's going to keep you asleep at night. And we also have to wonder if the Fed has enough attention right now. There was recently the photo that came out of Jerome Powell allegedly enjoying a dead-in-company concert or at least walking at one, doing who knows what. Asit, you really have to wonder, is he taking his eye off the ball? Ricky, I've thought about this a lot. Actually, this is where we spend our time, right? This is

the analysis that we strive to do for our members. I want a relaxed and refreshed Jerome Powell as he's interpreting inflation numbers. I mean, better that than being sleepy, grumpy, and overworked. That's a rate-raising formula. So I want someone who's been able to have some fun as well. All work, you know? You're saying that after one dead concert. What about the second one? What about the third one? What if he starts moving on to other jam bands and spending most of his time there, Asif? This is a slippery slope for a Federal Reserve chairperson. Tis, Ricky. The day that we have to follow Jerome Powell around from dead concert to dead concert is the day we're going to say that the Fed has lost total control of this economy.

I want to dive into this Adidas story from a couple of weeks ago in Bloomberg. Great piece by Kim Basin and Tim Lowe. It's titled Adidas After Yeezy. And it's about how Adidas is essentially cleaning up the mess and trying to become profitable again. After a long series of controversial comments, Adidas broke ties with Ye, the rapper formerly known as Kanye West back in October. I don't want to dunk on Ye. He's clearly going through a lot of issues that I can't even imagine. But now, the apparel maker is dealing with a lot of the fallout. Yeezy sneakers for a while were actually a pretty good response to Nike's Air Jordan. They're these highly collectible and sought-after products, and actually made up 8% of Adidas' total revenue and more than 40%

of the company's profit, according to a Morgan Stanley analyst. Before we get into the fallout, Austin, I think it's worth reflecting on how Adidas got there, where you have this one line of shoes tied to someone who doesn't even work at the company, making up almost half of your corporation's profits. Well, some of this goes back to European envy, watching a company called Nike evolve out of Oregon. It seems like the backwoods of Oregon into this global giant. And they did that partly following a formula that Adidas itself perfected over decades, which is the celebrity endorsement. Traditionally, that's been the athlete endorsement. We had this really special mix with Nike and Michael Jordan, a once-in-a-generation athlete

and an exploding interest in consumer goods, sneakers, a young population. I don't know if we'll ever replicate that kind of growth again, but Adidas felt itself on the outs with so many endorsements. I think they decided to go for a proposition that held a lot of risk, but such reward because Kanye has traditionally brought a huge audience through social media, through music listeners, to any proposition he's touched. So the potential was always there. The thing that I question in retrospect is the amount of risk that Adidas was willing to take. You alluded to Kanye's volatile personality, and clearly he has had some issues as of late, But Adidas executives knew what they were getting when they decided to go all in with

Kanye. And the extent that their inventory balance could at some times be 20% to 25% or more comprised of Yeezy line sneakers is sort of mind-boggling. Yeah, for these sneakers, Ye was an independent business that earned money off every shoe sold, end quote. and he got an 11% royalty on every pair. That, I think, is significantly more than what Jordan got for the Air Jordans. To your point, yes, he is very good at getting attention. I was a fan of his music, so I'm not going to lump myself into the people who would say, oh, I always didn't like

the guy, but I can't imagine working with him. Going forward to today, though, Adidas is facing a difficult choice because they have 500 million euros of stocked up Yeezy inventory. That's actually an increase from the previous quarter. Apparently, they're finding more and more of these sneakers laying around the warehouse. They had essentially four choices. What do you do, Asit? You can unstitch the logo one by one off every shoe. You can donate the shoes to disadvantaged companies. You can destroy them, burn them, maybe turn the rubber into turf pellets, or you can just sell them and figure out a different marketing angle to sell them, which is, I guess, what eventually Adidas was going for.

I mean, there are no good options here, right? Number one, unstitch the logos, too costly. Number two, you have this brand danger from pirating, which I think the article mentioned. You donate in goodwill these sneakers within disadvantaged countries, and then people start pirating them in the aftermarket. it, you have consumer outrage, that's brand damage. No. 3, destroy them, that's brand damage as well because the environmental cost is so high and you'll have consumer outrage once again. You're left with option No. 4, but I don't know. Again, when you load up

on inventory in such a big way, you should always be thinking of the worst-case scenario. What would happen if tomorrow this marketing partnership broke? I just still am incredulous that they made the choices that they made. I always wonder about, number one, it's too costly. These are $200 shoes, Asit. You can't get a pocket knife and knock off a couple of logos. But I think it's also worth reflecting on who made the decision. This seemed to have come from a CEO who was only focused on the numbers. Going back to the article, Kasper Rorsted was a Danish number cruncher who did time at Oracle, Hewlett Packard, immediately got rid of distracting divisions at Adidas and built up its e-commerce operations

to cut out the middleman retailers. While doing so, he really focused on classic shoes that sold well, but may have overloaded the market. You focus on these big stars like Ye, who wants a direct line to him and begins this very difficult relationship. Business, finance, all of this stuff where we see conditions in the black, companies making money, it's about more than the number crunching, at least over longer stretches of time. This idea of having risk, taking profit because you're taking risk, but not putting in risk mitigation, so not forming that really difficult personal relationship with Ye and learning how to manage him on a personal level, that was the most important thing for adidas to do of all the decisions they made foregoing the

difficult process of having that close bond and being able to manage him which i hate to put in those terms but that's what they were were asking for was a mistake so they used prox profit maximization as a first principle and wishful thinking as a second principle i don't think you manage, yeah? I think you do your best to work with them. They even sent people to Cody, Wyoming to work on the designs of these shoes with him, only for him to leave just a few months later. I really feel for the people at a couple levels down that had to be a part of that. Let's go to today, where Adidas might be turning around. The apparel maker has $800 million in cash. That's down, though, from $3 billion a year ago. It's also significantly increased its debt

short-term borrowings rose from $40 million to well over $1 billion today. Asit, is this now a company that has some balance sheet risk? I think it does, Ricky. These are rough numbers. They're a little different, at least on the Yeezy inventory, than the 500 million euros we talked about. But let's call it a rough billion bucks worth of Yeezy inventory. Adidas now has $5.7 billion of inventory on its books, and they only owe vendors about $2.3 billion in their payables. The inference is that they've used some former cash to invest in this inventory. That's actually good in terms of turning it over, even though we know it's going to turn over more slowly. They also have about $2.8 billion in receivables on their book, so

money that's owed to them. When you look at those debt commitments, there's about $1.5 billion spread over the next, well, less than two years. That's where you get tight here. They've got decent working capital, but they're going to have to manage the company pretty closely. I mean, another thing that surprised me, as all this is going on, Adidas has a share buyback of $2.5 billion last year, in a year in which they have negative $1 billion in free cash flow. Was that a great decision? Clearly not. So, now Adidas has a new CEO, Bjorn Golden. He came over from Puma. We're about six months from the fallout. What do you think Adidas' as Path Forward looks like, and are you buying their turnaround story?

I think this is one where we just monitor it from quarter to quarter. It's not micro, it's a small path forward. It's a mix of modest branding deals, regional profit orientation, not loading up too much in any specific geography on new inventory, working through that easy inventory, thinking about profitability and free cash flow first, then worrying about competing with the likes of Nike, again, at some point. This is a great brand. It's a global brand. It's still very strong. But any more of these misguided bets, bad inventory pilots, which incidentally, they've had plenty of outside of Yeezy, just bad calls on next season's trends, that's shareholder money that's potentially going to just languish there for a period of several

years. This could be a lot longer than a two or three-quarter turnaround story. I say watch it. It's not my best idea for investing in the consumer goods space this year. We'll see how they continue to throw things against the wall and see what sticks. Asit Sharma, always a pleasure catching up with you and thank you for your time and your insight. Same here, Ricky. This was a lot of fun. Even if you like managing your own finances, you might want a second opinion. Alison Southwick and Robert Brokamp dig into the process of hiring a financial advisor, how much you can expect to pay, and the value of working with a good one.

I don't know you personally, dear Motley Fool money listener, but I can make an educated guess about you. You are not the type of person to let someone else be 100% in charge of your finances. I'm guessing this because you're listening to this podcast after all. And our anecdotal evidence is that most Motley Fool money listeners are at least partially do-it-yourselfers, and we get it. The Motley Fool was founded 30 years ago on the belief that with enough time and curiosity, and then a newfangled thing called the internet, most people could manage their own finances, and they'd likely be better off by not paying thousands of dollars for Wall Street's conflicted advice. Now, just consider this estimate from a calculator on the website of the Securities and

exchange commission. Let's say you hand over $100,000 to be managed by an advisor. You pay 1% a year for that service, and the investment earns 8% annually. After 20 years, the total amount in fees you'd pay is almost $85,000, so nearly as much as your initial investment. It could certainly pay to be in charge of your own money. But it could also be challenging for an individual to become an expert in every single aspect of financial planning. And you don't want to find out too late that you didn't have something quite right. So, one solution is to check in with a professional financial planner once every five to 10 years. All right. So, that was the big switcheroo on everyone, saying that, yeah, you can do it

yourself, but then, actually, you should get professional help. So, what's the deal, bro? Really, it comes down to the fact that financial planning could be pretty complicated. It requires as being sufficiently knowledgeable about taxes, insurance, retirement accounts, Social Security, estate planning, college savings, all kinds of stuff. And with enough time and diligence, I do think that most individuals can learn almost enough to do most of their own financial planning. However, getting a review from a professional still could pay off for two primary reasons. First, your knowledge may have some gaps because, frankly, you have a job, you have a family, other responsibilities, probably other interests. And you likely have not had the time to delve

deeply into every aspect of personal finances. But secondly, professionals use software that is much more sophisticated than the free tools you're going to find on the internet. These programs can crunch the numbers on just about any financial decision, and it allows for really extensive customization, so the results really are based on your unique situation. Put in the hands of an experienced financial planner who can choose realistic, well-informed assumptions, explain the conclusions, the reports created by these tools will provide an analysis of your finances that you just can't get on your own. In fact, I fully expect that at some point before I retire, my wife and I will hire a financial planner just to give us a second

opinion on everything we're doing. Okay. So, let's say you've convinced some of our listeners to at least consider getting some professional advice. Where should they start? Because not everyone offering financial advice out there is created equally. Yeah. And I would say the first step is to think through what you are looking for. Do you want the whole enchilada, or do you just want to go a la carte? In other words, do you want someone to handle everything about your money, or are there just one or two aspects about your finances that you want evaluated, such as help deciding whether you're saving enough for retirement or college, or maybe how much you can safely spend in retirement, or whether you have enough insurance,

things like that? There are also a few other scenarios in which I think hiring a financial pro could make sense. One is, you frankly may already be working with a financial advisor, but you're not sure that they are giving you good service, so you want a second opinion on what she or he has been doing for you. Another scenario is that you and your spouse can't agree on key aspects of your financial plan, and you kind of need sort of an objective expert to act as the referee and to help make the decisions. Another one, and I think this is important for almost everyone, is that you're within a year or two of retiring, and there are so many decisions that go into retiring, right? You have to make the right decision about Social Security, about

Medicare? Which accounts to tap first? What's the right asset allocation in retirement? How's your tax situation going to change? And so on. A couple of other scenarios. One here is that you're just getting on in years. And you may want to begin a relationship with an advisor who can take over when you're no longer capable of or just interested in handling your finances. And I think this is particularly important if just one spouse is in charge of the finances. And that's generally the case for most marriages. You may want to begin a relationship with an advisor now while the more financially savvy spouse is available to help to be part of the process. Then finally, maybe you just haven't gotten around to doing all the financial things you know, and you need some

professional pro to kick you in the assets. Start by coming up with a list of the services that you need, and then look for a planner who can provide them. All right. Where should someone begin their search? It starts with how the advisor gets paid. We generally recommend that you look for a fee-only financial advisor who gets paid by the hour, by the project, maybe by a retainer, or as a percentage of assets under management. The advisor does not and cannot earn commissions based on products or investments that you buy. What's wrong with commissions? Well, they represent a potential conflict of interest. Not everyone who sells products are bad people, but there's still that potential conflict of interest because you don't know if the advisor's recommendations

are the best for you or best for their commissions check. Fee-only financial advisors, on the other hand, generally get paid the same regardless of the advice that they provide, so their main incentive is to do right by you. Now, some advisors will say that they are fee-based, which sounds like fee-only, but it's actually a hybrid, and it means they can still get commissions from a company for selling their products. Another benefit of fee-only financial planners is that most are fiduciaries, which means they are legally obligated to put your interests ahead of their own. Now, surprisingly, many financial advisors are not obligated to give you the very best advice. They're just required to give you quote-unquote suitable advice. And

this gives them a lot of latitude to sell you mediocre products with higher payouts for them. So, where do you go to find fee-only financial advisors? Well, there are a few networks. One is the Garrett Planning Network, G-A-R-R-E-T-T, National Association of Personal Financial Advisors, otherwise known as NAPFA, and the XY Planning Network. You just go to their websites, you enter your zip code, and you'll see a list of planners who are licensed to work in your state. Now, some may live in your city, others may live elsewhere, maybe not even in your state, but they can still do planning over Zoom and Dropbox and other virtual services like that. So, you choose a few who offer the services you're looking

for. You reach out to them. You schedule free meetings. These are often called get acquainted meetings just for you to talk about whether they're the right fit for you. Then you choose the person to go with. If I'm in this right fit meeting, let's say you're doing it. Bro goes and he has a right fit meeting with a financial planner or advisor. What maybe are some good things you're looking for this financial advisor to say or do, or maybe some red flags that would make you say, okay, this is not the right person for me? Well, if you've come up with the list of the services you are looking for, and you say, hey, this is what I'm looking for, if they keep trying to push you into something else,

let's say you just want someone to analyze your retirement plan, and they keep pushing you to say, you know what, I think I should manage your money as well, then you know that may not be a right fit. The other thing you want to do is look for someone who has experience working with people like you. In your general economic status, or maybe there's something unique about you, maybe you're a business owner, you want to look for someone who has experience working with people who are also business owners. Same with teachers, lawyers, doctors, whatever profession you have. A lot of financial planners specialize in working with gig workers and people like that. That's actually a great way to find someone for referrals. Let's say you are a graphic design artist.

look at some sort of local organization for your profession, and often the folks who are in that organization will be able to recommend financial planners who work with people in your profession. Is there any way to tell if someone's just competent? Ron and I went and we met with a financial advisor once, and he was late to the meeting and his office looked like a bomb went off in there. It was an absolute disaster. That's definitely not a good sign because you want a financial planner who's organized, that's for sure. I feel like it's easy to think like, oh, well, this person's an expert, so it's okay if I'm getting bad vibes off of them because they know more than me, so I'm just a big dummy,

and da-da-da-da-da. But it is okay to be like, no, there's something wrong with this person. Yes. You want to feel comfortable with the person, number one, for sure. But also, you can check their history. There are a few ways. If the person's a broker, there's something called broker check. If they're a registered investment advisor, the SEC has an advisor check. You basically find it on the internet, you enter their name, and you will see if there have been any regulatory problems, any complaints. If someone's been in the business for a long time, they'll probably have one or two complaints. What you want to see is that they got resolved. If they have many complaints and you see that they

have worked with many different firms, that's a bad sign because they might be kicked out of one firm and they have to keep joining another one. Let's move on. How much is this going to cost someone? The large majority of financial professionals get paid by managing your money. That's mostly what they want to do. The average annual fee is around 1% of assets. The financial planning is usually included, but you want to ask about that to make sure. You'll get something like annual reviews and things like that. advisors have asset minimums, so anywhere from $250,000 to $500,000. You have to have that much that they can manage for them to work with you. On the other hand, you may just want a one-time

analysis of a specific aspect of your finances while you continue to manage your own portfolio. For this, you'll need to hire a planner who works on an hourly or project basis. A pioneer of this type of service is the aforementioned Garrett Planning Network, founded by Cheryl Garrett in 2000. Cheryl is one of my personal heroes. Every member of the network is an independent certified financial planner practitioner who offers hourly-based advice, though some also will manage investments if that's what you want. According to Justin Nichols, the director of operations for Garrett, the average hourly rate across the network is $225, with most falling in a range of $175 to $350. Most offer

what has come to be known as real-time planning, during which you sit with the planner for an hour or two or three and just fire off questions, and you get expert answers right there on the spot. That said, a full-fledged financial plan takes more time, up to eight to 12 hours. You do the math and you can see that a comprehensive financial plan is going to cost you a few thousand dollars, so it's not cheap. But over the years, I've seen countless instances of people making big mistakes or even just suboptimal decisions. For many people, paying for unbiased expert guidance could be one of the best investments they'll ever make. All right, Bro, bring us home. What are your final thoughts here?

Well, I should point out that investment management and some financial planning services are offered by many of the big-name fund providers, discount brokers, robo-advisors. The services are generally available only to people with a certain level of assets, and then they charge a percentage of those assets to manage the money and then offer some financial planning advice. However, not all of these advisors have earned the certified financial plan or designation, and most are not fiduciaries. So, you definitely want to dig into the qualifications of the advisors before you sign up. Now, one big firm that offers such services is Vanguard. And they have estimated that the value of working with a financial advisor

is basically the equivalent of earning an extra 3% a year on your investments, and what they call their, quote, advisor alpha. And this extra return, so to speak, comes from getting professional help with things like asset allocation, asset location, which is putting the right types of investments in the right type of accounts, rebalancing your portfolio, behavioral coaching so you don't freak out when the market is down, stuff like that. Your mileage will vary, but I think for the average person who is not particularly knowledgeable about investing in personal finance, may not be saving enough for retirement, getting professional help will likely pay off. But that doesn't describe most Motley Fool money

listeners who I do think know a thing or two about managing their money. So the return on investment for hiring a financial professional to get that second opinion might be smaller. That said, I do think getting an objective, expert, experienced second opinion will still likely turn out to be money well spent. Well, yet again, we have a mailbag episode coming up. So send us your questions and we will do our best to answer it on the show. you can email us at podcasts at fool.com. That's podcasts, plural, at fool.com. As always, people on the program may own stocks mentioned in The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear.

I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow. Thanks for watching!