Why Jefferies Just Downgraded Chinese Sportswear Brand Li Ning

Shares of Li Ning Co. Ltd. fell more than 4.5 percent Tuesday on the Hong Kong Stock Exchange after analysts at Jefferies downgraded it from Hold to Underperform, trimming their price target from HKD4.0 to HKD3.3, on the back of weak fundamentals.

While the analysts expect steady growth in the Chinese sportswear industry in the near term, they are worried about increasing competition amid industry consolidation, and the resulting surge in marketing expenses.

Regarding Li Ning, the firm highlights the fact that fundamentals remain weaker than its competitors, "with high channel inventory turnover of c8months (vs. 4-5 months at key peers), weak channel profitability, and a weak balance sheet.”

It's not only the weak fundamentals that make the experts less optimistic on a fast turnaround. Other factors like “frequent changes in strategy” and a recent management restructuring also impact on their expectations.

Mr. Li Ning recently took over as interim CEO at the Chinese company, but Jefferies believes “a stable long-term management and strategy is required in the competitive industry amid an industry consolidation phase.”

Expansion targets also create concern among analysts.

“We are cautious on Li Ning’s store network expansion target of 500 stores in 15e,” the Jefferies note explained. “It had a net reduction of 34 stores in 1Q15, suggesting net addition of 181 stores per quarter in 2Q-4Q15 required in order to meet the target, which is the expansion speed at the peak cycle before 2010. With weak profitability of distributors, long cash cycle (indicated by c8 months channel inventory turnover days), and Li Ning’s need to control cost for turnaround, we are cautious on the likelihood of rapid expansion in wholesale stores.”