China's 'Consumption Downgrade' Trips Up Anta

Key Takeaways:

• Anta said sales of its Fila branded products contracted in the third quarter as increasingly cautious Chinese consumers gravitated towards cheaper products
• Despite the Fila slowdown, analysts still expect the company’s revenue to grow 16% in the second half of the year, supported by sales of its other brands

By Doug Young

Why purchase pricey foreign sportswear with names like Nike and Fila when you can get the same products from domestic brands like Anta or Li Ning for less?

That’s the question shadowing Anta Sports Products Ltd. ANPDY, whose upscale Fila brand showed signs of slipping in the third quarter, according to the company’s latest quarterly update issued last Thursday. More specifically, Anta reported its sales of Fila products, a Korean-owned brand that it sells in China under a licensing agreement, fell by a “low single digit” amount in the three months to September.

The third-quarter decline for Fila is quite significant, as the brand is one of Anta’s most profitable, carrying higher margins than its core Anta brand. The Anta brand accounted for nearly half of the company’s sales in the first half of the year, with Fila not far behind at nearly 40%. The rest, about 14%, comes from other upscale brands like Descent and Kolon Sport.

Fila’s third-quarter sales decline contrasted with its performance in the first half of the year, when its revenue rose by 6.8%. Even then, Fila was a relative laggard to Anta’s other two main brand groupings, with revenue from Anta-branded products up 13.5% and “other products” up 41.8% for the six-month period.

Investors got a bit spooked by the latest announcement, with Anta shares falling nearly 9% on Monday, the first trading day after the update. Despite that, the stock is still up 20% year-to-date, including a 30% gain in the last month amid a broader rally for Chinese stocks.

Anta is the largest, and an investor favorite, among China’s sportswear makers, boasting a relatively high price-to-earnings (P/E) ratio of 18. By comparison, the next largest player, Li Ning LNNGF trades at a lower 13, while smaller rival 361 Degrees TSIOF trades at just 8.

All of the retailers are coming under pressure these days as Chinese consumers rein in their spending with the country’s slowing economy. Retail sales in China grew just 2.1% in August and 2.7% in July, far slower than rates seen in the past when the economy was booming.

A sub-story of the retail slowdown has been what’s locally called a “consumer downgrade,” referring to the growing consumer preference for cheaper products over more expensive ones within individual categories. That downgrade is affecting everyone in the retail sector, with more upscale brands like Starbucks and Nike losing business to lower-priced rivals like Luckin Coffee and Anta.

Starbucks reported in July that its China same-store sales tumbled 14% in the three months to June, as the average size of an order fell 7%. Similarly, Topsports TPSRF, the main seller of Nike and Adidas shoes and sportswear in China, last month said its profit tumbled 35% in the first half of its fiscal year through August. It said its revenue also fell for the period, blaming dampened consumer sentiment that was affecting the entire retail sector. It added that its margins were also taking a hit from discounting and promotions, as well as inventory buildup as a result of slowing sales.

Tale Of Two Brands

With all that background in mind, we’ll return to the story of Anta and the diverging paths between its original Anta-branded products and Fila, whose China rights it acquired more than a decade ago. In its latest financial report for the first half of this year, Anta refers to Fila as its “high-end athletic fashion brand that targets high-end consumers across a wide range of age groups.”

Fila’s second-quarter sales decline contrasts with a mid-single digit sales increase for Anta-branded products during the period, according to the update. Here we should also note that even the Anta brand is facing some economic headwinds, since its latest growth represents a slowdown from the 13.5% year-on-year growth it recorded in the first half of the year.

Fila-branded products commanded a gross margin of 70.2% in the first half of the year, well ahead of the 56.6% for the Anta brand, reflecting Fila’s premium nature and bigger contribution to the company’s profits. That means the contraction of Fila sales in the third quarter is likely to pressure Anta’s bottom line in the second half of the year, especially if the brand’s sales continue to decline.

The story wasn’t all bad for Anta, as its “other products” category, which also consists of more premium foreign brands, actually rose between 45% and 50% in the third quarter. That figure represents an acceleration from the category’s 41.8% growth in the first half of the year, as Anta probably spends aggressively to promote these other premium brands like Descente and Kolon Sport.

Anta also has a positive story to tell in Amer Sports AS, its foreign subsidiary based in Finland, which owns the Wilson and Arc’teryx brands, and was spun off and separately listed in the U.S. early this year. Amer previously reported its revenue rose 14% in the first half of the year to $2.18 billion, powered by a 52% rise in its Greater China sales that accounted for about 10% of the total, as it leverages its Anta connections to grow in that market.

Amer’s shares have also performed quite well since their IPO, and now trade about 50% above their listing price of $13.

Despite the contracting Fila sales, Anta is still expected to post revenue growth of about 16% in the second half of the year, boosted by stronger performance for its other brands, according to the average of 44 analysts polled by Yahoo Finance. That testifies to the company’s strong management that has made it the leader in China’s sportswear market.

The company’s stock will probably continue to command a premium to its peers for its size and strong margins. But at the end of the day, even Anta can’t stop the forces of a slowing Chinese economy and the growing consumer preference for cheaper domestic brands over pricier foreign ones.

This article is from an unpaid external contributor. It does not represent Benzinga's reporting and has not been edited for content or accuracy.