Most organizations face financial challenges classified based on their attributes. Financial challenges affect business functionality, impeding operational difficulties which may lead to loss of sustainability power of an entity (Pointer & Stillman, 2004). It is in this regard that the study evaluates the appropriate strategy to remedy Adidas from its financial challenge, as the problem is largely affecting its operational efficiency. Therefore, the study focuses on providing a strategy to overcome the financial challenge affecting the company, and through guidance from business valuation outcomes, the appropriate strategy is identified. It is found that Adidas should expand on its ownership structure to add more debt funds to finance its operations, as well as leverage its value.
Analysis of the financial challenge facing Adidas
Adidas owns a recommendable progress in terms of performance, characterized by its growing revenue over the analysis period. However, the company is facing a financial challenge characterized by high operating expenses, which may adversely affect its performance in the future (Adidas, 2017). Critically, the forecasted operating expenditure level accounts to 64.17 per cent of its gross profit, signaling high level of operating costs on its activities. Despite this posing a financial risk to the company, emanating from decline operating efficiency, the challenge may lead to loss of company value, as it leads to low profitability in the company. Apparently, it is evident that the challenge has led to a low forecasted net profit margin and the operating profit margin, accounting to 10.32 per cent and 17.20 per cent, respectively.
Loss of company value is common in instances of low profitability, as there is low return on assets as well as on the capital employed (Wahlen, Baginski, & Bradsh, 2010). This is an indication of low efficiency, which leads to decline in the value of the supply chain of the company. Moreover, with a low return on capital employed, investors worry about the sustainability power of the company, thus opting to hold less capital in the company. As a result, the growth rate of the company declines, as there is low level of invested capital, affecting its going concern attributes (Drury, 2004). Therefore, the financial challenge facing Adidas is worth to be proactively amended, to limits its spread effects on the company at large. Moreover, operating efficiency in an organization provides a strong operating backbone of a company, leading to the attainment of a strong financial muscle for thriving in the market space.
In business valuation, key concepts are evaluated to determine and evaluate the sustainability of an entity (Stickney, Weil, Schipper, & Francis, 2009). Therefore, based on the available information in the forecasted financial statements of Adidas, the valuation is based on its profitability, efficiency, as well as financial health of the company. This is done via various ratio analyses, as the ratio metric helps to determine the relative performance of the company.
Financial health valuation
Apparently, the financial strength of the company in relation to the industry and past history is recommendable, as it is ranked to have 7 out 10 in the ranking scale. This is mainly contributed by cash to debt ratio of 1.78, which is higher than the industry value of 1.45 (MorningStar, 2018). This is an indication that the company owns more net cash from operating activities than the average current liabilities. In addition, the company is in a position to pay its maturing obligations when they fall due for payment. This certifies the credit worthiness of the company, as its liquidity position is strong (Lumby & Jones, 2003).
In additional, the amount of assets that shareholders can claim from accounts to 44 percent, but this is lower than the industry average, whose level is 58 percent (GuruFocus, 2018). This means that almost 50 percent of the asset value equates to shareholder’s equity, a level which is recommendable to investors. This guarantees a sustainable return and minimal loss in instances of solvency. Importantly, on an average of 10 years, the maximum equity to assets ratio is 47 percent. In addition to its financial strength, Adidas has a promising future characterized by low debt in its capital structure. Based on the debt to equity ratio value, the company owns a debt level which equates to 17 percent of its equity value, a level lower than the industry average which is 34 percent. With strong capital structure, characterized with strong liquidity position and equity-asset ratio, the financial health of the company can be termed as strong, providing evidence of strong valuation exhibited by the company. This can be illustrated by the diagram below.
Profitability and growth valuation
The operating margin of the company is 9.6 percent, making it being ranked as one of the companies in Global footwear and Accessories industry with a meaningful operating profit. The industry operating profit level is 5.92 percent, an indication that the industry operating expenditure level is high. Despite Adidas being ranked among the best companies in the industry, this level of performance is not recommendable, as it lowers its financial muscle to run effectively its operations. Moreover, with a low operating profit margin, the company is characterized by a low net profit margin of 5.12 percent, which lowers its profitability growth prospects.
Investors in the company realizes a return accounting to 17.01 percent of its earnings, a figure higher than that of the industry, which accounts to 7.59 percent of the industry’s earnings. Apparently, the company has an appealing performance in the industry, but the investment competition operates above the industry boundaries, thus terming its performance as non-appealing to the majority of investors. This lowers its growth power, as investors tend to focus on companies with high returns in other industries. Moreover, the negative perception on the company by investors is detrimental to its survival rate, thus increasing solvency chances (Gocejna, 2014). This can be illustrated by the diagram below.
Investor’s perspectives valuation
Investors add up the capital in an entity, with anticipation of return from the entity’s earnings. Therefore, the valuation of the company in terms of earnings and share prices plays a fundamental role in determining the investment profile in an organization. Adidas’ investors are required to pay $ 35.94 to earn a dollar of the company earnings, a price which is higher than the industry average, whose stock price per industry earnings is $ 20.38. This is an indication that the company shares are overvalued in comparison with the industry, a factor that may lead to loss of investors. This is a similar case when the analysis is based on the predicted earnings verses current stock price, as the company forward price earnings ratio is $ 24.04. Investors in the industry are required to pay less by $ 7.35, a factor that will adversely affect the company valuation by investors. This can be illustrated by the diagram below.
From the valuation reports, it is evident that the company financial health is recommendable, but much need to be done on its profitability and growth, as well as its investment profile in terms of pricing, as both experience a lower performance than the industry average.
Overview of an appropriate strategy to overcome the financial challenge
The financial health of Adidas ascertains its sustainability power, thus exiting the business is not an appropriate strategy of recovering from its financial challenge. In addition, improve its spending will add more to its prevailing challenge, and its investment valuation lowers its credibility in obtaining additional equity. Moreover, its stock is priced higher than the industry average, thus having a low investor’s interest. Therefore, to recover from the prevailing financial challenge, the company needs to acquire more funds through changing ownership of its capital structure, through additional of debts in its capital.
With its strong financial health, characterized by strong liquidity position and low debt levels, inclusion of additional debt will provide funds to finance its operating expenditure. Moreover, additional of extra debt helps in leveraging the value of a firm, thus gaining more value from investor’s perceptions (Adam, 2015). In the long term, the value of the company will improve, providing a sustainable power over its operations.
Inefficient operations in an entity lead to financial challenges that impact the value of entity in association with the rate of growth of its sustainability power. Apparently, as a financial challenge facing Adidas, its operation efficiency is at risk if proactive strategies would not have been taken place to remedy the situation. Moreover, with inclusion of additional debt capital in its ownership structure, the entity achieves a financial muscle to remedy its ailing operations, as well as attain a leverage value emanating from debt financing.
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Gocejna, M. M. (2014). Investor Expectations in Value Based Management: Translated by Klementyna Dec and Weronika Mincer. Boston: Springer.
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Lumby, S., & Jones, C. (2003). Corporate Finance: Theory & Practice. Boston: Cengage Learning EMEA.
MorningStar. (2018). Adidas valuation . Retrieved March 19, 2018, from http://www.morningstar.com/stocks/PINX/ADDYY/quote.html
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