China Sportswear:3Q16was a good quarter;4Q16could be even better

We recommend accumulate Li Ning and Pou Sheng now, Anta if pullback

    We do not worry about Li Ning’s slowing off-line SSSg, as we view theprofitability recovery as intact. In 3Q16, Anta delivered the most upsidesurprises, with accelerations in Anta Adult, e-commerce and Fila. Fila’s strongperformance shows that the sports fashion style is still intact in China,cementing our conviction on Pou Sheng. Given the low base, Anta’swholesaler incentive program and its robust e-commerce, we believe sellthroughcould remain strong in 4Q16. We like Li Ning and Pou Sheng formargin turnaround. Our long-term preferred stock remains Anta, due to itsmulti-brand strategy.

    Li Ning: weaker off-line SSSg does not hinder profit recovery

    Li Ning’s overall 3Q16 SSSg (retail, wholesale and e-commerce) was in linewith our expectation, increasing by high-single-digit PPTs YoY (Figure 1). Yet,slowdowns at both retail and wholesale stores surprised us to the downside.Having conducted more studies, we believe the slowdown is driven more byvolume. We estimate healthy ASP (narrowing retail discount) in 3Q16, but wealso believe consumers have delayed purchases (into the 1 October holiday)and that there are inventory shortages in selected regions. Given the robustimprovement in retail discounts and the initial success in reducing wholesalerrebates, we remain confident in Li Ning’s profitability turnaround.

    Anta: three major accelerations in 3Q16 acted as upside surprises

    The Anta brand (excluding Fila and Descente) reported sell-through growth inthe low-double-digit PPTs YoY (Figure 2), beating our expectation of “similar to2Q16”. 3Q16 sell-through was characterized by three surprising accelerations:(1) Anta Adult’s (大貨) growth accelerated, driven by stabilized weatherconditions and narrowed retail discounts YoY. This is a major surprise, as ourchecks suggest no meaningful acceleration. (2) E-commerce, partly due toAnta’s sustainable efforts to boost flagship stores (Tmall and JD) whilecracking down on unauthorized operators. (3) Management indicated asignificant acceleration in Fila. We estimate Fila’s sell-through growthaccelerated from “over 30%” in 2Q16 to “over 50%” in 3Q16, indicating thatthe current “athleisure” cycle in China remains intact. We find this supportsour Buy on Pou Sheng (3813 HK), the main operator of Adidas Originals (acomparable brand to Fila) in China.

    4Q16 sell-through growth likely robust

    On offline, we expect continued easy comps for Li Ning, and we anticipateAnta’s wholesaler incentive program to bear fruit in 4Q16. Overall sportswearconsumption appears to be strengthening, judging from robust 1 Octoberholiday performance at Li Ning, Anta and Pou Sheng. On e-commerce, theSingles’ Day shopping festival is clearly a major event for all brands. Anta aimsto double its sales YoY during the Singles’ Day in 2016, while Li Ning is poisedto strengthen its O2O capability.

    Industry valuation and downside risks to our positive industry view

    We value the sporting goods space using discounted cash flow (DCF), as weexpect investors to focus on the companies’ long-term growth potential. Wesupport our valuations using PER, derived using the historical cycle or peercomparisons. Downside risks: weaker cyclical recovery, weaker innovation,sports segmentation and e-commerce failing to drive growth for the sector.