Adidas senior unsecured debt credit rating downgraded to A3 from A2 the long-term issuer ratings of Adidas AG. Moody’s also downgraded Adida’s short-term issuer rating to Prime-2 from Prime-1.

RATING RATIONALE

Today’s rating action is prompted by a steep profit warning for 2023, announced by the company on 9 February, signalling a significant and unexpected further downward revision of the company’s financials and credit metrics for the next 12-18 months. This profit warning comes at a time when Adidas was already fairly weakly positioned in the A2 rating category, with a negative outlook since November 2022. While Moody’s expected a weak operating performance in the next 12-18 months, the actual guidance is well below Moody’s expectations.

adidas published a very weak sales guidance for 2023 and expect, at best, to post an operating loss of €200 million (and a €700 million loss under a stress scenario) for the full year, mostly due to the potential losses from not disposing of the existing Yeezy inventories, as well as other one-off items for up to €200 million. The magnitude of these losses for 2023 is significant and well above Moody’s initial expectations. Since the termination of the partnership with Ye (Kanye West) announced in October 2022, Adidas initially expected to repurpose and sell the remaining products under the Adidas brand over time. While the new earnings guidance seems to be conservative and reflects a very disciplined approach to bringing down elevated inventory levels as well as a cautious stance given the weak consumer sentiment in Western markets, high inflation, recovery challenges in China and some restructurings, it also raises some questions about the company’s core operations (excluding Yeezy) and their underlying profitability. Given all these uncertainties, Moody’s believes there is high downside risks to its medium-term forecasts.  

While the company has published preliminary sales and earnings figures for 2022, it has not disclosed cash flow and liquidity information, nor information about the potential long-term savings from the additional cost efficiency measures announced for 2023. With the new guidance, Moody estimates that Adidas’ credit metrics will remain below the agency’s requirements for an A2 rating in the next 12-18 months. More specifically, Moody’s expects a leverage ratio (Moody’s-adjusted gross debt to EBITDA) to peak at around 5.6x in 2023, possibly 10x under the company’s worst scenario guidance. These levels are materially weak, deteriorating further from an estimated 3.4x in 2022, and exceeding the 2.5x threshold for the A2 rating. Moody also sees a rising uncertainty about longer-term recovery prospects, owing to persistent inflation and weak consumer sentiment, which will likely translate into a slow earnings recovery and elevated leverage for 2023-24.

Governance considerations were an important driver of today’s rating action. Moody’s believes that the company’s multiple earnings revisions over the past 7 months as well as the very weak earnings guidance for 2023 raise some concerns about Adidas’ risk management and the strength of its underlying business. While the company faced multiple external one-offs, notably the exit from Russia, the termination of the Yeezy partnership and extensive lockdowns in China, Moody’s believes that the company has demonstrated weaker risk and financial policies in the last 12 months. In particular, Adidas’ extensive dividend and share buy-back strategy in 2022 while facing substantial trading headwinds and supply chain issues, resulted in an elevated net leverage and high cash burn. As a consequence, Moody’s assessment of the company’s Financial Strategy and Risk Management was changed to 2, from 1. Having said that, Moody’s still factors in Adidas’ commitment to maintaining conservative financial policies, with a net leverage ratio under 2.0x (Net borrowings to EBITDA as adjusted by the company). adidas will likely be breaching its net leverage commitment in the next 12-18 months, but expects the deviation to only be temporary. Moody’s expects the company’s net leverage to return below this threshold, over time, towards end-2024.

In addition, the weaker track record in recent years and the uncertainty over the new management’s turnaround strategy, which has yet to be announced, also weigh on Moody’s assessment of Management Credibility and Track Record, which was changed to 3, from 2. As a result, the overall exposure to governance risks (Issuer Profile Score or “IPS”) was changed to G-3, from the previous G-2, and Adidas’ Credit Impact Score to CIS-3, from CIS-2.

Adidas A3 rating continues to reflect the company’s leading position in the global sportswear industry, significant scale and wide geographical reach; its strong brand recognition, supported by product innovations and significant marketing and sponsorship investments; the favourable long-term prospects of the sportswear industry, with increasing health awareness of customers; its good liquidity and conservative financial policies.

Adidas liquidity is good and supported by a cash balance of €806 million as of 30 September 2022  (although eroded compared to €3.8 billion at end-2021) as well as committed and uncommitted credit lines amounting to around €4.0 billion of which the vast majority was unused, including its fully available committed revolving credit facility (RCF) of €2.0 billion. As at end-September 2022, Adidas had short-term obligations of around €1 billion, including a €500 million convertible bond due in September 2023, which has been pre-financed by a €1 billion bond issuance in November 2022. Moody expects Adidas’ free cash flows (FCF) to be deeply negative in 2022, mostly due to the fall in earnings compounded by very high inventory levels. The company’s Moody’s-adjusted FCF was materially negative in the last 12 months to September 2022, at €1.7 billion. Moody’s expects FCF to be positive in 2023 on the back of inventory clearance, lower capital spending and lower dividend payments.

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