Can JD Sports survive the threat of direct-to-consumer shopping?

Exactly one year ago, Britain’s offices endured a mass exodus. Under strict ‘stay at home’ rules, businesses were forced to adjust rapidly to a remote model, facilitated by the likes of burgeoning tech platform Zoom Video Communications (US:ZM).

But other aspects of work also changed; not least the notion of the office wardrobe. By blurring the line between the professional and domestic spheres, the Covid-19 pandemic catalysed an existing trend towards comfortable dressing over formal attire. Many swapped out jackets for jerseys and ties for trainers as they moved from computer screen to living-room exercise class.

Admittedly, the ‘athleisure’ market has not been immune to the blow dealt by virus restrictions, which have repeatedly pulled the shutters down on non-essential shopfronts. But its rising popularity and retailers’ ability to continue selling online during the crisis have helped the sector to fare better than other parts of the apparel industry.

Demonstrating such resilience, spending on casualwear, homewear and sportswear in Europe declined by 5 per cent, 7 per cent and 17 per cent last August against pre-pandemic levels. By comparison, spending on fashion, business and occasion clothing fell by a more pronounced 26-37 per cent, according to a report from McKinsey and the World Federation of the Sporting Goods Industry (WFSGI).

And industry players believe there is further growth on the horizon. Germany-quoted Adidas (GER:ADS), the second-largest sportswear manufacturer in the world, predicts that the sporting goods market will expand at a mid-single-digit compound annual rate between 2021 and 2025. This would see it swell by €100bn (£86bn) and thus “outpace a poor economy by a factor of two”. Crucially, the group believes the focus will be “much more digital” – anticipating that online sales will grow three times faster than physical channels.

Taking greater control of sales channels

Preparing for those shifts, Adidas and its larger US-listed rival Nike (US:NKE) have centred their attentions on e-commerce, while simultaneously capitalising on the shutdown of high streets to take greater control over their digital offerings. Indeed, both companies hope to lift the proportion of their revenues stemming from direct-to-consumer (DTC) engagement – effectively cutting out some of the middlemen, or third-party retailers, in their networks.

The potential benefits of such a strategy are clear. All being well, DTC should bring Adidas and Nike better margins, while granting them deeper customer insights – something that could, in turn, translate into higher sales.

But the digital and DTC transition requires considerable investment and is not without risk. It also has significant implications for both brands’ distribution partners, including FTSE 100 group JD Sports (JD.), which is due to post annual numbers on 13 April.

Adidas and DTC

“Consumers expect to receive a brand and shopping experience tailored to their preferences, with personalised offerings in both digital and physical spaces,” Adidas said last month, as it explained that it would “evolve its operating model” to address customers more directly.

Key to such evolution is Adidas’s membership scheme, which rewards customers with points for making purchases and using Adidas apps. Members more than doubled last year to 165m across 15 countries, and the group hopes to triple this figure by 2025.  In turn, as outlined in its ‘own the game’ growth strategy revealed on 10 March, the group expects DTC to account for half of total net sales.

Results for 2020, posted the same day, offered up a strong starting point. DTC revenues (including own-retail and e-commerce) constituted more than two-fifths of total sales last year, up from a third in 2019. In tandem, the proportion of wholesale revenues dropped from roughly two-thirds to 59 per cent.

Overall, sales dropped 16 per cent to €19.8bn, having been hit hard by store closures in the second quarter before turning to growth in the fourth.

‘Consumer direct offense’

Nike embarked on its own “consumer direct offense” in 2018. Management picked up the pace of this journey last June with a new phase termed the “consumer direct acceleration”. Like Adidas, Nike seeks to advance its digital sales via a membership platform that keeps customers engaged and loyal to its brand.

‘Nike Direct’ comprised almost two-fifths of total revenues for the group’s third quarter ending 28 February, having risen 16 per cent to $4bn.  This improvement, buoyed by strong digital growth, helped to offset the impact of declines in Nike’s wholesale business after virus-induced supply chain challenges in North America and mandatory store closures.

Commenting on the group’s latest numbers, management said its direct-to-consumer strategy was “driving a meaningful and broader marketplace shift” and “transforming our financial model”. Overall, Nike’s quarterly sales rose 3 per cent to $10.4bn and its gross margin edged up 1.3 percentage points to 45.6 per cent – helped, bosses noted, by its “more profitable” Nike Direct business.

What is the threat to JD?

How worried should JD’s investors be about the threat of direct-to-consumer sales? The group has, itself, acknowledged the competitive tensions at play – flagging the rise of DTC when it responded to the competition watchdog’s decision to block its acquisition of Footasylum last May.

At the time, JD said it fundamentally disagreed with the UK’s Competition and Markets Authority (CMA). Aside from the impact of Covid-19 on its industry, the group observed that “UK sports retail is one of the most dynamic and intensely competitive markets in the world”.

Within that market, “a large number of retailers selling third-party brands compete not only with each other, but also with major online pure-players and the increasingly powerful direct to consumer (DTC) operations of the international brands themselves”.

The Competition Appeal Tribunal upheld an appeal from JD in November, arguably lending weight to the group’s observation of intensifying rivalry.

Scale and diversification

That said, for now JD’s stores and online channels remain strategically important to big-name athletic labels. The shift to DTC could even present opportunities. “While the sporting goods sector is seeing significant changes in the way brands distribute, we think JD Sports is standing out as a partner of choice for these brands,” say analysts at JP Morgan.

It helps that the group boasts international scale and diversification, putting it on a stronger footing than smaller peers. Beyond its eponymous ‘JD’ brand, which was founded in Bury in 1981, the group’s M&A activity has established a portfolio spanning several countries in Europe, Asia and – more recently – America.

JD entered the US for the first time in 2018, acquiring Finish Line, a retailer with stores in 44 states. Its push across the Atlantic continued last year when it bought Shoe Palace on the West Coast, while also opening a flagship JD Sports store in Times Square, New York. Just this month, the group bought Baltimore-based DTLR for $495m (£359m).

But JD is still focused on opportunities beyond the States, too – agreeing to take a 60 per cent in Polish retailer MIG on 11 March. And, aided by such deal-making activity, the group’s revenues span multiple regions. For the half year to 1 August 2020, the UK constituted just 38 per cent of sales while the US accounted for a third.

Store appeal

Such reach has bred leverage with big brands. JD is one of Nike’s top customers globally, notes Shore Capital analyst Greg Lawless, meaning it has access to new products faster than other distributors.

And while digital sales have sat front and centre during the coronavirus pandemic, JD’s physical retail estate will still hold appeal, Lawless argues. “There will be a role for the store,” he says, “either as a showroom to showcase the product” or “in the service proposition to get technical help”.

‘Inside the tent’

As Jonathan Pritchard at brokerage Peel Hunt sees it, DTC is “a massive threat to retailers that don’t have strong relationships with Nike and Adidas”. But it is less of a threat for those “inside the tent”.

Nike and Adidas “know that ultimately the way we want to shop is in a multi-brand environment”, Prichard says, “whether that’s physical or online”.

However, it is more profitable for these companies to go down the DTC route. So they “have to find a balance between the two”, Pritchard observes. That balance is “to essentially remove relationships with the less strong retailers, or the less progressive retailers”, says Pritchard, “and increase the strength of the relationships with those companies that they think are very forward-looking and have the same thought-processes as them”.

In Pritchard’s view, “JD is probably as far inside the tent as it’s possible to get”. Those inside the tent “will get the allocation of product, in most cases, that they want”, he says. “It’s the lesser retailers that are going to find their allocations potentially struggling over time”, and these are “mostly mom and pops”.

Topping expectations

Just as investors have backed Nike and Adidas over the past year – valuing them at $218bn and €54bn respectively – they have also continued to support JD’s investment case. Its shares have risen 130 per cent over the past 12 months, giving the group – whose top shareholder is, incidentally, family-run business Pentland – a market cap of £8.6bn.

Little wonder, perhaps. JD retained 90 per cent of sales at the six-month mark last summer, aided by a successful shift to online trading despite the challenging pandemic backdrop. Moreover, a January statement revealed that full-year headline pre-tax profits would be significantly ahead of expectations, reaching at least £400m. JP Morgan’s forecast sits at £415m, on sales of £6.2bn.

Having tapped shareholders for £464m earlier this year, JD is primed for further acquisition opportunities. In Pritchard’s view, the group’s balance sheet strength is “extremely important in securing the deals that are going to turn them from a nearly global retailer into a global retailer”.

Such status would, presumably, make JD even more essential as a distribution partner. Ahead of this month’s results, hold at 838p.