The major distributor for Nike and Adidas in China is struggling with lingering consumer boycotts for some of its goods and Covid-related store closures

Key Takeaways:

  • Topsports’ revenue and net profit fell in the first half of its fiscal year on tight pandemic controls in China and ripple effects from a cotton sourcing controversy
  • Some analysts believe that the company will continue to clear its inventory in the latter half of its fiscal year, though such efforts would pressure its gross margin

By Fai Pui

Anyone notice that some international sporting brands in China are offering bigger discounts these days?

The biggest motivation for such discounts is often inventory clearance. Global sportswear giants Nike (NKE.US) and Adidas (ADS.DE) are cases in point, each doling out generous discounts in China periodically as their local sales sag. Such discounting is taking a toll on Topsports International Holdings Ltd. (6110.HK), their biggest China distributor, which last week announced its worst interim results in four years.

Topsports’ challenges have been building up over the past two years. It took a hit after some international brands stopped using cotton from China’s Xinjiang region over controversial labor practices, leading some Chinese consumers to broadly boycott foreign apparel brands in favor of their domestic rivals. Adding to the woes, severe Covid-control measures to limit the spread of the highly contagious Omicron variant in the second quarter and beyond led to long-term forced closures for its brick-and-mortar stores in affected areas.

That double-whammy showed up on the company’s top line, with its revenue falling by 15.1% year-on-year to 13.2 billion yuan ($1.8 billion) in the six months through August. Its revenue from Nike and Adidas sales fell by 14.6% to 11.54 billion yuan, accounting for 87.3% of total sales. Revenue from other brands such as Puma, Converse, Vans, North Face and Timberland fell by an even larger 18.2% to 1.56 billion yuan.

The company’s gross profit fell by a slightly milder amount, but was still down 12.9% to 6.03 billion yuan. But strains from the pandemic forced Topsports to boost its sales, marketing and administrative spending, bringing down its net profit by 19.9% to 1.15 billion yuan. Despite all that, the company threw investors a small bone by maintaining a dividend of 0.13 yuan per share.

Trimming the fat

While many factors are beyond its control, the company has accelerated its store closures to rein in costs. It closed 857 directly operated stores by the end of August compared with its count a year earlier, bringing its total to 6,928. The vast majority of those closures – some 767 – came between March and August alone. It also trimmed its headcount by nearly 20% over that period from 40,913 at the end of February to 32,745 by August.

In another fat-trimming exercise, the company has continued to replace its more numerous smaller-format stores with a smaller number of large-format ones. Its stable of big-format stores, ones more than 300 square meters in size, grew to 1,030 over the latest reporting period, accounting for 14.9% of total stores from a previous 12.9%. Meantime, smaller stores with 150 square meters of space or less fell by 686 during the period, and now account for 56.8% of the total. Overall, the company’s gross sales area dropped by 5.1%.

Vigilant cost-cutting efforts aside, investors might also take comfort in signs that the company’s online-offline “dual channel” model is bearing fruit. The company isn’t giving any revenue data yet, but said the number of registered members for that initiative grew 28% year-on-year during the latest period to 60.2 million. Management added that online sales have also risen markedly, and community-based online private-domain sales have grown the fastest, with that element’s contribution to total sales doubling.

Independent equity analyst Ivan Chow is on the fence about the company. He said Topsports had to offer big discounts after being unable to sell a big chunk of its inventory, leading to product depreciation that will continue hurting its profits.

The value of Topsports’ inventory at the end of August fell slightly by 4.2% from the level in February to 6.4 billion yuan. But the average inventory turnover period moved in the opposite direction, rising by as many as 19.8 days to 167.6 days. That means investors will need to watch closely for signs of how fast the company keeps its inventory from getting out of control in the latter half of its fiscal year.

Downward revisions

China’s slowing economy and pandemic-related uncertainties have led investment banks to lower their forecasts for Topsports. Credit Suisse now projects a 10% year-on-year decline for the company’s retail sales in its fiscal third quarter through November as a result of pandemic resurgences in September. It also believes online promotions the company will launch during the upcoming “Double 11” shopping festival will weigh on its gross margin, and lowered its forecast for the company’s earnings per share in its fiscal 2023 and 2024 years by 21% and 24%, respectively. It also lowered its target price for the stock from HK$7.30 to HK$5, and maintained a “neutral” rating.

Daiwa Securities acknowledged that Topsports’ dividend payout ratio of 70.4% exceeded its projection, while still revising down its earnings per share forecast for the company by 12% to 16% over the next three years. It also lowered its target price from HK$9 to HK$7.30. Macquarie thinks that the company’s sales won’t start improving until late next year due to lower-than-expected traffic in its brick-and-mortar stores and China’s ongoing pandemic-related restrictions. Accordingly, it revised down its profit projections for the company in the next two years by 13%, while lowering its target price from HK$8.50 to HK$7.80.

Topsports shares fell by 12% in the four trading days after it announced its latest results, with the stock closing at a record-low of HK$3.96 Monday, down 71% from last-year’s high of HK$13.78. Its market value is now only HK$24.5 billion ($3.14 billion), half of where it was at the time of its IPO three years ago. Domestic rivals Li Ning (2331.HK) and Anta Sports (2020.HK) have also seen their shares tumble to a 52-week lows in recent weeks amid weakness in the broader Hong Kong stock market.

In terms of valuations, Topsports’ projected price-to-earnings (P/E) ratio has fallen to 8.8 times, much lower than 20.8 times for Li Ning and 17.5 times for Anta. That shows there’s clearly a discount for Topsports, whose gross margin as a distributor for other brands is much lower than the other two that have their own brands that are typically more profitable.

Chow believes investors would be wise not to expect too much from the company despite its lower valuation. He said China’s continued implementation of its “zero-Covid” policy and broader stock market weakness, combined with dim prospects for China’s property market, were all depressing confidence among middle-income consumers who typically buy pricier sportswear. Thus, now may not be the right time to invest in such stocks.

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