Topsports stalled by foreign brand ties, pandemic controls (undefined:TPSRF)

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Has anyone noticed that some international sports brands in China are offering bigger discounts these days?

The biggest motivation for such discounts is usually inventory liquidation. Global sportswear giants Nike (NKE) and adidas (OTCQX:ADDYY) (ADS.DE) are examples of this, each offering generous discounts in China periodically as their local sales decline. Such a discount is taking its toll on topsports International holdings ltd (OTCPK:TPSRF) (6110.HK), its largest distributor in China, which last week announced its worst provisional results in four years

The Topsports challenges have been piling up over the past two years. It took a hit after some international brands stopped using cotton from China’s Xinjiang region due to controversial labor practices, prompting some Chinese consumers to widely boycott foreign clothing brands in favor of domestic rivals. Adding to the problems, stringent 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 in the company’s results, with its revenue falling 15.1% year-on-year to 13.2 billion yuan ($1.8 billion) in the six months to August. Its sales revenue from Nike and Adidas fell 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 an even further 18.2% to 1.56 billion yuan.

The company’s gross profit fell by a slightly smaller amount, but was still down 12.9% to 6.03 billion yuan. But the strains of the pandemic forced Topsports to increase its sales, marketing and administrative expenses, reducing its net profit by 19.9% ​​to 1.15 billion yuan. Despite all that, the company threw investors a bit of a bone by keeping a dividend of 0.13 yuan per share.

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trimming the fat

While many factors are out of its control, the company has expedited its store closures to control costs. It closed 857 directly operated stores at the end of August compared to its count a year earlier, bringing its total to 6,928. The vast majority of those closures, some 767, occurred between March and August alone. It also cut its workforce by almost 20% during that period, from 40,913 at the end of February to 32,745 in August.

In another fat reduction exercise, the company has continued replace its more numerous smaller format stores with a smaller number of large format stores. Its group of large-format stores, those over 300 square meters, grew to 1,030 during the latest reporting period, representing 14.9% of total stores from 12.9% previously. Meanwhile, smaller stores with 1,500 square feet of space or less shrank by 686 over the period and now account for 56.8% of the total. Overall, the company’s gross sales area fell 5.1%.

Cost-cutting efforts aside, investors might also take comfort in signs that the company’s online and offline “dual channel” model is paying off. The company has not yet given any revenue data, 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 sharply, with online community-based private domain sales growing fastest, with that item’s contribution to total sales doubling.

Independent equity analyst Ivan Chow is undecided about the company. He said Topsports had to offer deep discounts after failing to sell much of its inventory, leading to product depreciation that will continue to hurt profits.

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Topsports’ inventory value at the end of August fell slightly 4.2% from February’s level to 6.4 billion yuan. But the average inventory turnover period moved in the opposite direction, increasing as much as 19.8 days to 167.6 days. That means investors will need to watch for signs of how quickly the company prevents its inventory from spiraling out of control in the second half of its fiscal year.

downward revisions

The slowdown in China’s economy and uncertainties related to the pandemic have led investment banks to lower their forecasts for Topsports. Credit Suisse is now projecting a 10% year-over-year decline in the company’s retail sales in its fiscal third quarter through November as a result of resurgences of the pandemic in September. He also believes that the online promotions the company will launch during the upcoming “Double 11” shopping festival will influence its gross margin and lowered his forecast for the company’s earnings per share in its fiscal years 2023 and 2024 by 21% and 24 %, respectively. . It also lowered the share’s price target 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 lowering its earnings per share forecast for the company by 12% to 16% over the next three years. . It also lowered its price target from HK$9 to HK$7.30. Macquarie believes the company’s sales won’t start to improve until late next year due to lower-than-expected traffic at its physical stores and restrictions related to the ongoing pandemic in China. Consequently, he revised down his profit projections for the company in the next two years by 13%, while lowering his target price from HK$8.50 to HK$7.80.

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Topsports shares fell 12% in the four trading days after its latest results were announced, with shares closing at an all-time low of HK$3.96 on Monday, down 71% from the year’s high. passed from 13.78 Hong Kong dollars. Its market value is now just HK$24.5 billion ($3.14 billion), half of what it was at the time of its initial public offering three years ago. domestic rivals Covering (OTCPK:LNNGF) (2331.HK) and ANTA sports (OTCPK:ANPDY) (2020.HK) have also seen their shares fall to a 52-week low in recent weeks amid weakness in the broader Hong Kong stock market.

In terms of valuations, Topsports’ projected P/E ratio has dropped to 8.8 times, much less than Li Ning’s 20.8 times and Anta’s 17.5 times. That clearly shows that there is a discount for Topsports, whose gross margin as a distributor of other brands is much lower than the other two that have their own brands that are usually 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 “covid-zero” policy and broader stock market weakness, combined with gloomy prospects for China’s real estate market, were depressing confidence among middle-income consumers who typically buy most expensive sportswear Therefore, now may not be the right time to invest in such stocks.

Divulgation: None

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Publisher’s note: The bullet points in this article were chosen by the editors of Seeking Alpha.

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