As a discretionary good, sportswear may seem an unlikely
winner in the wake of COVID-19. But the category—which includes athletic
apparel and footwear—has some unique characteristics that make us think it will
emerge just fine. In fact, for stronger companies, we believe COVID-19 will be
an accelerant as the companies leverage their connections with consumers and
drive business through more profitable channels.
A Long Runway for Growth
The total addressable market (TAM) in the sportswear space is estimated at $472 billion globally.
WHAT IT MEANS: Total addressable market is a term that is typically used to reference the revenue opportunity available for a product or service.
At William Blair Investment Management, while apparel and footwear is a low-growth category overall, we have seen sportswear take increasing share over time. Sportswear increased from about 18% of the apparel category in 2007 to almost 26% in 2019.
In fact, sportswear has shown a 6.5% compound annual
growth rate (CAGR) over the past five years, one-and-a-half times that of the
apparel market
We believe this trend will continue, driven in part by a
growing middle class around the world. Per capita sportswear spending in
emerging markets, particularly China, is one-tenth that of the United States,
and has plenty of room to grow.
Economic Cycles: Mostly Background Noise
The sector’s behavior in response to economic cycles has
been mixed. While there is an impact from the economic backdrop, there are many
times that results have been detached from the economic cycle.
For example, sportswear growth peaked in 1995 and
decelerated through 1999, leading the stocks to underperform the broader
market. After bottoming in 1999, sportswear started a five-year growth
acceleration, leading to strong stock performance.
This is exactly the opposite of what the broader market
was doing: The market peaked in 2000, and growth slowed as the U.S. economy
went into a recession in March 2001.
As the chart below shows, the S&P 500 Index peaked at
roughly the same time sportswear bottomed, presenting a prominent case for how
sportswear performance has detached from the economic backdrop at times.
WHAT IT MEANS: The S&P 500 is a stock market index that measures the stock performance of 500 large companies listed on stock exchanges in the U.S.
This was also apparent after the 9/11 attacks,
where we saw sportswear quickly recover despite continued weakness in the
broader market.
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We saw more economic sensitivity
during the global financial crisis (GFC). Both the S&P 500 Index and
sportswear companies peaked around the same time, within two to three months of
each other.
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However, sportswear fundamentals
were fairly resilient. Revenues across the group declined 3% in 2009 and
earnings before interest and taxes (EBIT) were down 35%, but there was a strong
rebound in 2010. While sportswear fundamentals recovered within five to seven
quarters, sportswear stocks surpassed prior peaks within a year of
bottoming—much faster than the market, due to clear visibility and robust
growth.
The key takeaway: economic cycles
matter, but they have not been as impactful as we might think they would be. We
are seeing a number of sportswear companies perform outside of the economic
cycle.
Product Cycles: Critical in the Near and Medium Term
To understand the sportswear
space, one must appreciate product cycles. While sportswear companies are not
high-fashion companies, there is a fashion element to their success, and they
need to remain on trend.
WHAT IT MEANS: A product cycle is the length of time a product is introduced to consumers into the market until it's removed from the shelves
The chart below illustrates how
three key sportswear companies performed in past product cycles.
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A running-related product cycle
started in the mid-2000s. It was interrupted somewhat by the GFC, but then came
back with a vengeance. This is when we saw the Nike Free and Vibram Five
Fingers products take off.
Sportswear Company 1 in the chart
above was well positioned for this cycle; Sportswear Company 3 was not. As a
result, Sportswear Company 1 outperformed Sportswear Company 3 significantly
from 2012 to 2015.
Then, from 2015 to 2018, retro
sportswear came into fashion. Sportswear Company 1 continued to push the
running platform while Sportswear Company 3 was on trend for retro. Guess which
outperformed?
We are now in a new product cycle
that we call high fashion and collaborations. Brands are collaborating with
different designers and luxury houses (Kanye West, Selena Gomez, Beyoncé, Dior,
and Off-White to name just a few), and new product releases are coming out
monthly if not weekly. Most leading brands are participating successfully in
this trend.
There are two key takeaways.
First, the category has a degree of fashion risk (such as the move away from
technical performance and athletic functionality), although it is less
pronounced than in luxury or casual wear.
Second, once we identify companies
that we believe have strong brand equity and solid management teams, we need to
make sure we are patient, because even the best will potentially miss a trend
and have a period of underperformance relative to peers.
Investment Opportunities
Over time we have seen brands
rationalize their supply chains, allocating more orders to what we would call
key manufacturing partners. We view key suppliers as strategic partners and
more akin to internal manufacturing than external. A single supplier, for
example, manufactures about one-sixth of Nike’s shoes globally.
We also see this happening on the
distribution side. Brands are culling undifferentiated wholesalers and
diverting more in-demand products to strategic retail partners. We view these
retail partners as part of a brand’s direct-to-consumer efforts more than
wholesale.
The return on invested capital
(ROIC) for these strategic partners is typically fairly robust and at times has
exceeded the brands’ ROIC, indicating that there is substantial value creation
throughout the entire value chain.
WHAT IT MEANS: Return on invested capital is a calculation used to assess a company's efficiency at allocating the capital under its control to profitable investments. The return on invested capital ratio gives a sense of how well a company uses its money to generate profits.
On that note, we see a long runway
for brands to shift sales from the wholesale channel (70% of Nike’s and
Adidas’s business) to the direct-to-consumer (DTC) channel, which includes
their own retail footprints and e-commerce operations.
WHAT IT MEANS: Direct-to-consumer is the selling of products directly to customers, bypassing any third-party retailers, wholesalers, or any other middlemen.
We believe the big brands have the
potential to reach about 50% DTC penetration in the next 10 years, and perhaps
even higher over the long term. Some estimates place DTC at 70% of the sales
mix.
While brands do not provide the
profitability difference between the two channels, we estimate that DTC
generates double the revenue and EBIT dollars of wholesale, underscoring just
how accretive the mix shift from wholesale to DTC is.
WHAT IT MEANS: EBIT stands for earnings before interest and taxes, and is a company's net income before income tax expense and interest expenses are deducted.
Sportswear in the Wake of COVID-19
We have long identified health and wellness as a structural theme driven by consumers being increasingly concerned by the connection between their lifestyle (physical activity and food consumption) and their overall health.
COVID-19 and the potential health
risks have intensified the desire to eat better, live better, and feel better.
We believe sportswear is well positioned to benefit from this as consumers
express this desire through active lifestyles.
While we believe the long-term
view for sportswear remains positive, COVID-19 has presented an unprecedented
situation resulting in a coordinated global retail shutdown. The ensuing
consumer weakness (such as unemployment), combined with a broader apparel and
footwear inventory glut, will likely hurt discretionary spending overall.
This will undoubtedly depress
near-term sales and margins as sportswear companies adjust to overall market
conditions.
Despite these challenges,
sportswear appears to be a resilient category in the midst of COVID-19, and not
just because the pandemic appears to have intensified consumers’ desire to
focus on their health and wellness.
Sportswear companies, over the
past few years, have woven digital engagement into their DNA. Their ability to
speak directly to an audience without a physical footprint, amplify their
messaging, and drive engagement has allowed them to drastically accelerate
online sales during the lockdown.
Multiple brands, for example, have
reported triple-digit e-commerce growth in China throughout the lockdown,
helping them offset lost brick-and-mortar retail sales.
While the pace of the recovery
varies by brand and region, we are encouraged by what we are seeing and
anticipate that sportswear sales will be one of the fastest discretionary
categories to recover, as we have seen in prior downturns. As retail conditions
normalize globally, so will sportswear sales.
After all, the category has a long track record of value creation over the past 30 years. We have every reason to believe this will continue over the long term.
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