China Sportswear (Part 1: Industry)
China Sportswear (Part 1: Industry)
China's homegrown brands are the structural winners
Chinese stocks have been beaten down as of late, with plenty of companies hovering at decade lows.
Particularly compelling, in my view, are the Chinese homegrown sportswear firms Anta and Li-Ning. Putting money where my mouth is, I made them into sizable positions in my personal portfolio, having first entered into them in late 2023 and steadily averaged down since then. Keep in mind that this is not investment advice - the discussion here is intended for informational purposes only.
Part 1 of this report will examine the evolution of China’s sportswear industry and the relevant industry context. Importantly, we will discuss the key structural backdrops that underpin the compelling opportunities I see today in the Chinese sportswear companies.
Parts 2 and 3 will be a discussion on Anta and Li-Ning, delving into the company-specific factors. This part will also feature up-to-date insights from store visits that I conducted earlier this month in Beijing.
Let’s first talk about how the industry got here.
The size of China’s sportswear market was roughly RMB 400 bn (US $56 bn) in 2023, according to Anta.
Over a long enough time horizon, China’s sportswear industry has comfortably recorded double digit historical CAGR. But the trajectory hasn’t been linear, with the major stages shown below.
China has a long history with sportswear - first as a contract manufacturer (exporter) of Western brands since the 1980’s and 1990’s. But it was only in the 2000’s that China’s domestic consumption of sportswear entered a rapid growth phase. The years leading up to 2008 were some of the fastest growing years as excitement built up around the Beijing Olympics. The Chinese economy was also firing on all cylinders. Every sportswear producer during this time recorded phenomenal growth.
While China possessed a globally competitive sportswear supply chain, the country’s homegrown brands have for a long time operated in the shadows of foreign brands. Astute entrepreneurs realized that the money was not in contract manufacturing, but rather in owning the brands. One of them was Ding Shizhong, Anta’s 54-year old founder, who came from a family of factory owners. Anta was initially established as a contract manufacturer in 1991, but transitioned to become a branded sportswear in 1997. Today, Anta is the largest sportswear company operating in China, having surpassed Nike in total sales.
Chinese brands, including Anta and Li-Ning, recorded rapid growth leading up to and shortly after the Olympics, until around 2010. This was a story of classic boom and bust. Overly optimistic demand forecasts from the Olympics hype led to overexpansion. Between 2011-2014, the sportswear market entered a correction territory with painful inventory reduction and waves of store closures. Most Chinese brands recorded flat to declining revenue during this time.
The early 2010’s also marked a period of strong growth for foreign brands including Nike and Adidas. Foreign brands benefitted from the trend of consumption upgrade, propelling their popularity to new heights while Chinese brands languished. As we’ll discuss in detail later, Li-Ning struggled the most during this post-Olympics digestion period, while Anta did better but primarily owing to its success with Fila China (acquired in 2009) which occupies the premium category in China. In 2009, Nike had 13% market share and Adidas 10%. In 2018 this would reach 21% for Nike and 20% for Adidas. The combined shares of the two had almost doubled! In particular, the dramatic rise of Adidas is noteworthy (as is its subsequent dramatic fall post-2019).
Foreign brands seemed unstoppable, until the tide started to turn around 2019, when Chinese brands saw their popularity rise. One factor was geopolitics. As US-China relations soured, Chinese consumers gave domestic brands a boost. It came to head with the Xinjiang cotton incident in 2021, when foreign brands found themselves at the center of the controversy, facing a 'damned if you do, damned if you don’t’ type of dilemma.
The follow chart illustrates the market share trend in recent years (note: Brand N = Nike, Brand A = Adidas, Brand L = Li-Ning, Brand S = Sketchers)
It’s important to recognize that while geopolitics had indeed been a significant influence, it's misleading to attribute all the market trends simply to it alone (as one might conclude if only paying attention to news headlines). When you look under the hood, the competitive landscape had already started to shift.
You have to recognize that the 2011-2014 glut period was a tough one for many Chinese firms, but it was also during this time that many significant management improvements had started to take shape.
For example, Anta’s Ding explained that one of the biggest structural changes undertaken during this period was a change in the management focus from wholesalers to prioritizing retail sell-through. Essentially, it’s an admission that up until then, the business had simply been about stuffing the wholesale channel. Management invested more in IT to facilitate unified data gathering and analysis across channels. In addition, it strengthened oversight over retail store operations to provide consistent high quality customer experience, along with better enforcement of pricing policies. The 2010’s period was significant in terms of the professionalization of operations by the Chinese players.
In my view, geopolitics is akin to a catalyst that reveals “who has been swimming naked when the tide runs out”, to borrow the famous line by Warren Buffett. For instance, a huge disparity was seen in the fates of Nike and Adidas, even though they are both foreign brands. In theory they should be impacted similarly by geopolitical events. In the end, market share shifts still boil down to fundamentals. Even before the Xinjiang incident, Adidas had already started to show signs of fatigue including high inventory, excessive discounting, channel mis-management, and a fundamental loss of brand appeal to Chinese consumers.
To sum up, Chinese brands could not have done as well as they have, had it been purely geopolitics and unrelated to the fundamental progress that have been made in their businesses across all areas from product design, technology, marketing and sponsorships, to retail and consumer experience.
In the rest of this report, we’ll examine the fundamental backdrops shaping the industry from three key perspectives - policy, consumer trends, and geopolitics.
Policy
Every investment in China should start from the fundamental question of: how does the industry or business fit within China’s long-term development? It’s befitting that we discuss policy first.
If you ask people what they think China’s strategic development areas are, you’d probably hear things like semiconductors, high-end manufacturing, energy, aerospace, and so on. Fair enough, these are perhaps the most important. What I’m trying to get to is that I bet you won’t hear many people say “sports”. China has a clearly stated goal to become a major sports power. Sports development is featured in China’s Five Year Plans with highly concrete goals outlined. Historically sports has received strong governmental support, and in recent years the emphasis has only grown.
Why is sports something that the Chinese Communist Party cares about? You don’t have to speculate, because they are clearly stated in high level documents. First, harness the role of sports in building a “healthy China”. Second, enhancing “national cohesion” - China is becoming more nationalistic, and what’s better than sports to help build a nation’s cohesion and unity? And third, China sees sports as a means to project soft power and enhance “cultural competitiveness”. Athletes are universally admired across the globe regardless of race or skin color, serving as a source of inspiration for all. If you think about it, it’s quite smart and strategic.
The 13th Five Year Plan (2016-2020) marked a significant shift towards recognizing sports as an important industry, and its emphasis has carried over to the current 14th Five Year Plan (2020-2024). Let’s examine the key points.
In the 13th Five-Year Plan, the government established various sports-related targets, including:
Increase the sporting population to 435 million (this is more than most countries’ total population!)
Increase the per capita sports venue area to 1.8 square meters
Prioritize the development of three major ball sports: football (soccer), basketball, and volleyball.
It also encourages sports consumption:
Total sports industry scale to exceed 3 trillion yuan;
Contribution of sports to GDP of 1%;
Sports consumption to account for more than 2.5% of per capita disposable income of citizens.
In addition, there is a mention of cultivating sports enterprises: “focus on supporting and cultivating a group of backbone sports enterprises with independent brands, innovation capabilities, and competitive strength…enhance the value of Chinese assets in the sports industry field”
Now, looking back at the 13th Five-Year Plan, most of the quantitative targets above have been achieved. The 14th Five-Year Plan is essentially an extension and a more ambitious iteration introducing higher targets, for example raising the sports market scale from 3 to 5 trillion yuan, the GDP contribution from 1 to 2%, and expanding the per capita sports venue area from 1.8 to 2.6 square meters, among others.
However, a significant new element is the focus on youth sports development, which is entering a new phase. The goal is for youths to be proficient with 1-2 types of sports, and to utilize sports as a means to promote the physical and mental health of young people.
We’ve seen in the past few years that the government wants youths to spend less money and time on video games and after-school tutoring sessions. Ask yourself what area might be the beneficiary of this? It shouldn’t be too hard to connect the dot!
If you believe that the government can influence people’s actions in China, then it stands to reason that we can continue to anticipate an increased allocation of both people’s time and money towards sports.
Consumer trends (demand side)
In recent years, Chinese consumers have developed an increasing affinity for their homegrown sportswear brands.
This shouldn’t be a surprise, because it’s a trend hardly unique to sportswear. Homegrown brands have been taking shares across various sectors, from mobile phones to cars, appliance, cosmetics, and so on. It’s perhaps better to invert the question: are there areas where Chinese brands have not gained share over foreign brands? (I’m talking about within China, of course) Perhaps high-end luxury is one but can you come up with others?
A picture speaks a thousand words:
A senior executive at New Balance China discusses the evolving consumer landscape:
“The consumer is becoming more mature and with stronger intention to buy local brands compared to before. Compared to maybe three or five years ago, everyone just wanting to follow the logo, follow the Swoosh or the Adidas logo, now the consumer likes to try Anta and deal with local brands…I think the product development and innovation by the local brands are obviously improving a lot. They invest more and they change more and quicker so that consumers can easily find a replacement or a substitute product no matter whether it's a sneaker or a sports jacket or a yoga pants, etc. There are more and more options for them, not just only the big brands.”
New Balance Trading (China) – Sr. Finance Director & CFO (Sep 2022)
Of particular importance is the Generation Z group (born after 1995) who are now entering the workforce and witnessing a rise in discretionary income. Interestingly, Gen Z are known for having developed a stronger affinity with Chinese brands, more so than their predecessors. This is exemplified by the Guochao trend (“national wave” = fashion reflecting national pride or Chinese cultural influences) which has strongly resonated with Gen Z consumers.
This may even sound counterintuitive at first. Common assumptions might lead one to expect that the older generation should have stronger brand loyalty, particularly with a tendency towards “patriotic buying”, rather than the newer generation who are presumed to be more open to global influences. But the opposite has been the case - it is the younger generation that’s championing domestic brands. In my view this can be attributed to three factors:
Perception of Chinese Products: Unlike their parents’ generation, Gen Z does not harbor the same perceptions or stigma associated with 'Made in China', and views Chinese products in a more positive light.
National Identity and Pride: There's a heightened sense of national pride and confidence in their Chinese identity among Gen Z. This may be influenced by the educational system and social narratives of recent years that have increasingly emphasized patriotism and national achievements.
Post-materialistic Values: Gen Z is part of a post-materialistic shift away from conspicuous consumption that was characteristic of the previous generation. There's a growing appreciation for intangible aspects like experience and values.
These are sometimes reduced to just the term “patriotic buying” by the media, but I think the reality is more nuanced and involves a complex interplay of cultural factors. There is a broader shift in the values underpinning Chinese consumption, which investors would do well to better recognize.
Another consumer trend that we have witnessed recently is the shift towards value purchases.
“I think the Chinese economy is not very good (compared to before) so not all the consumers want to buy expensive items like luxury…now, many Chinese people prefer to buy something with affordable price but with good quality.”
It’s hard to distinguish how much of this is due to cyclical factors (weak economy) versus structural change in consumer habit away from conspicuous consumption. I suppose it’s a mixture of both. During Covid, consumers wanted to save money which prompted many to purchase Chinese brands. This gave them a firsthand experience of how far Chinese brands have come in terms of quality improvements compared to the past.
However, this trend can be a doubled edged sword for Chinese players. Their core mass market brands should continue to fare relatively well due to being quality-for-value, but some recent premiumization efforts, such as the “Li-Ning 1990” premium line, have taken a hit as consumers tighten their wallet. At the same time, the situation is nuanced - it’s not accurate to say that all premium segments have been hit. For instance, select brands like Arc’teryx and Lululemon have seen 60-70% CAGR since the pandemic. Premium brands can still do well, but they need a highly distinctive brand proposition, more so now than before, to succeed in a challenging economic climate.
Geopolitics (supply side)
We’ve seen how geopolitics plays a role on the demand side, boosting the appeal of Chinese brands to consumers. Here, it’s worth thinking about geopolitics again but from another angle - how it affects foreign brands operating in China, as well as the strategic responses of the global management teams behind these firms - i.e. the supply side.
Geopolitical friction manifests itself in different forms, with the Xinjiang incident being a prime example. It’s not the first time, and it certainly won’t be the last. Foreign brands found themselves being “cancelled” overnight by consumers, endorsers, e-commerce retailers, and even on web searches and ride-hailing apps. A case in point: famous Chinese actor/singer Wang Yibo cancelled his contract with Nike right after the Xinjiang incident, and a month later re-signed his contract with Anta.
Adidas and H&M were hit the hardest, with their quarterly revenue plummeting by 30-40%. It served as a check on the realities of doing business in China. Publicly, management will continue to emphasize their commitment to the world’s second-largest consumer market, but beneath the lip service, things may start to change. A decade ago, it was inconceivable for any company to not have "win in China” as their priority, irrespective of the costs. Today, it demands a re-evaluation. The biggest firms are having debates like this:
“How can you pretend that you understand Gen Z in Shanghai, in Beijing, based out of Bavaria, with all due respect to the people there because they have fantastic teams? You really need to unleash the creativity on the ground in China, but then the global view won't like it because then you start to have two very different phases of the brand. For right reasons, you need to optimize the business model, you need to have more synergies. You need to drive more efficiencies, creating a four to five to six to seven SKUs line in China next to your global business. Doesn't really work from a financial standpoint. Of course, the more you create a big range in China, the less China will buy into the global range, which drive your efficiency and your financial results. That's what I say it's a strategic decision to potentially say, "Well, maybe we don't want to be that big in China anymore. Maybe we want to reduce a little bit by having more synergies and more efficiency." However, then that means that puts more pressure onto the other market to deliver the growth.”
On the production side, diversification has already progressed for many years. 15 years ago Nike used to make 36% of footwear in China, compared to 33% in Vietnam. In 2023, this has shifted to 18% in China and 50% in Vietnam. Initially the shift was driven by rising labor costs in China, and had less to do with geopolitics. However, geopolitics is increasingly becoming a driving factor. For instance, the Uyghur Forced Labor Prevention Act in the US took effect in June 2022 - it assumes that any product made with goods, even partially, sourced from Xinjiang has been made with forced labor, unless a company can prove otherwise (Xinjiang produces 85% of China’s cottons and 20% of global supply). The cost of doing business in China is rising in terms of both legal risks as well as investor and consumer backlash.
The above pertains to production, and admittedly this is not the same as firms retreating from China’s consumer market. But I believe it does highlight an important theme. There is a new management strategy taking shape at multinationals - one that places more emphasis on having a “resilient global portfolio”, rather than putting eggs into a single basket. This implies that for China’s homegrown brands, the period of the most intense competitive rivalry with foreign brands is likely behind them. They have weathered the challenge, and in a sense, have “won”.
With these structural backdrops in mind, I believe investors should start thinking about the compelling opportunities in China’s homegrown sportswear brands today, namely Anta and Li-Ning. Not only are they considered the structural winners, but they are also compellingly cheap.
In Parts 2 and 3 we’ll take a closer look at these two businesses.
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