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(Reading time: 19 minutes)
When a great athlete retires, the doors to lots of possibilities open. Simply because with being more in control of their time, comes the ability to channel their winning mentality to other activities.
Since several sports stars retire with a large nest egg, they often end up in entrepreneurship. Venture building of legendary athletes and great business people.
Olympics are historically significant for Chinese people, being for years one of the only portals, for Western Countries, into the authentic culture of the Celestial Kingdom.
Mr Li Ning, the founder of Li-Ning Group, is a retired gymnast who conquered the market of sports apparel in Mainland China. Known globally as “The Prince of Gymnastics, Mr Li has won, during his career, 106 gold medals.
He knows something about discipline and time commitment: he channeled those “high performing” qualities into his business ideas. And, well, they yielded him a group that has revenues for HKD$ 14.46 billion (USD$ 1.86 billion at current exchange rates).
As the proud apparel supplier of several sports delegations in Mainland China and abroad, the LiNing group has to offer its investors an interesting opportunity to invest in a company that, in the years to come, will have a say in international sports apparel supply.
Right now, the market of sportswear in Mainland China sees Nike (22.9%) and Adidas (20.4%) dividing almost half of the shares, followed by Anta (16.4%), Sketchers (6.8%) and Li Ning (6.3%).
The Chinese group’s position in the internal market is weakening. However, Li-Ning counts on important partnerships with some of the most relevant sports delegations: the American NBA (basketball) and the British ATP (tennis).
Read along to see if the Li-Ning group is worth considering an investment!
1. The Company
History
The “Prince of Gymnastics” Li Ning retired from his sports career in 1988, after the Olympics in Seoul, which weren’t exactly brilliant for him, due to injuries and being off-form in general.
The Champion, however, after a year of inactivity, founds in 1990 the Li-Ning Company Limited, a sportswear and sports equipment company founded with the ultimate mission to serve as a brand that Chinese Olympians can wear during competitions.
The history from there on is pretty simple. The brand researched primarily internal growth, leveraging franchise monopoly marketing strategies in the Chinese sports market.
From 1992, the year of the Barcelona Olympic Games, Li-Ning Company Limited started supporting the five Chinese “Golden Dream Teams” (gymnastics, diving, shooting, table tennis and badminton).
In 2005, Li-Ning established a partnership to promote and sell the french AIGLE brand exclusively in China for 50 years.
The Group did the same shortly after with DHS, table tennis and other sports equipment brand, and Lotto Sport Italia SpA (a brand of Italian sports fashion) and Kason (a brand of professional products for Badminton).
In 2006 the company went on the papers for signing a four-year deal with Shaquille O’Neal, the former NBA player of Miami Heats (at the time of the agreement).
In 2008 Li Ning lightened the Beijing Olympics torch, empowering international awareness of the brand.
In 2010, Li-Ning opened its US headquarters in Portland, Oregon, and subsequently entered a partnership with Chicago-based Acquity Group to expand its American distribution and brand awareness in 2011.
During the years, the company formed several strategic partnerships with top international competitions and organisations, such as NBA and ATP, the Spanish Olympic Committee, the Spanish Basketball Association, the Swedish Olympic Committee, the Argentine Basketball Association and several international athletes.
Among them names like Asafa Powell, O’Neill, Ljubicic and Dwyane Wade, the former shooting guard of the Miami Heats.
Li-Ning has continued to grow year over year. Let’s see the structure of the company and the management that allowed it to surge to being one of the prominent apparel brands of Mainland China.
Structure of the company
Let’s start with the ownership structure.
The founder and current co-CEO of Li-Ning Company Limited holds a 13.3% stake (almost all of it through a trust called “Viva China Holdings Limited”). The rest, amounting to 86.7%, is public, and the company’s management controls between 2 and 3% of it.
To avoid the “Government risk”, the company has a single directly held subsidiary: RealSports Pte Ltd., incorporated in the British Virgin Islands. This is an investment holding used to indirectly manage 51 subsidiaries across the Greater China territories and South Korea.
Li-Ning Company Holding Ltd, then discloses six associate companies (all of them incorporated in greater China) that received investments from the group: significant influence is guaranteed under its contractual right to appoint directors.
Management Overview
Li-Ning Company Ltd can count on three executive directors: Mr Li Ning, Mr Kosaka Takeshi and Mr Li Qilin.
Mr Li Ning is the founder of the eponymous athletic apparel and footwear brand. Former worldwide-known gymnast, he is now the Group’s Executive Chairman, Joint Chief Executive Officer and Executive Director.
Mr Ning holds a bachelor’s degree in law from the School of Law of Peking University, an executive MBA degree from Guanghua School of Management of Peking University.
Li is involved in several foundations and charities, especially targeting initiatives that provide subsidies for further education and training for athletes and educational support in impoverished and remote areas of China.
Mr Kosaka Takeshi is a Japanese-Chinese (Qian Wei is his former Chinese name) executive Director and joint chief executive officer. Mr Takeshi joined the group in the September of 2019 and focuses on the operations of the group.
Mr Kosaka graduated from Kwansei Gakuin University in Japan, and before joining the company, he was the CEO of Uniqlo South Korea. His previous experiences are either inside Uniqlo PRC or its holding, Fast Retailing Co., Limited.
Mr Li Qilin is a young Executive Director and Member of the Remuneration Committee of the Company. Mr Li joined the group in 2017 as a Non-Executive Director and re-designated in 2018.
He has experience in the financial services industry as he worked as an analyst for Persistent Asset Management Limited.
To be noted, Mr Li Qilin is the nephew of Mr Li Ning and the son of Mr Li Chun, a substantial shareholder of the company.
2. Qualitative Analysis
Business Model Spotlights
The group belongs to a sector that in Mainland China is notably in the hands of international groups: sports apparel couldn’t count on solid Chinese alternatives to Nike and Adidas before Li-Ning entered the market scene.
Right now, the market share composition for sports apparel in Mainland China is the following:
Even though LiNing’s market share, at first sight, can seem thin, it has to be considered that both the sales volume of the sector and the company’s market share are growing steadily.
To give an outlook about the impressive growth that the market of Sportswear is having in China, let’s analyse the steady increase in sales value. The latest data is referred to the years from 2014 to 2019.
The market of Sportswear experienced incredible growth during the last decade, with several companies trying to gain traction and favour in the customer’s mind.
To make clear how LiNing makes money, let’s see what the main product lines that the company can count on are.
In 2020, the company made 6.3 billion yuan from the sale of footwear (accounting for 43.8% of total revenues), 7.4 billion yuan from the sale of apparel (51% of revenues) and 0.8 billion yuan from the sale of equipment and accessories (5.2% of total sales).
LiNing grew its revenue figure between 2019 and 2020, mainly thanks to its increased operativity in the e-commerce channels and the Nothern regions of the People Republic of China.
Instead, the group saw a plunge of almost 20% in international sales. The decline is due mainly to the closure of shopping centres and the continuation of the COVID-19 pandemic.
Due to the gradual shift towards online sales, LiNing has also been able, during 2020, to decrease its spending in distribution on distribution expenses to revenue scale.
Competitors and threats
Even though the market of sports apparel is highly populated in Mainland China, LiNing can count on being a Chinese-run company that targets especially customers in the Celestial Empire.
While Nike and Adidas are steadily controlling the market, LiNing suffers from the competition of its internal peers: Anta Sports and Xtep.
Anta Sports is the world’s third-largest sportswear company by revenue as of 2019.
While LiNing focuses on providing a few brands of international reach and more sport-specific items, Anta can count on an extensive portfolio of brands to be sold almost exclusively inside China.
The competition of Anta is difficult to rival, as the company holds 16%+ of the internal Chinese market. However, LiNing could become a well-known name in international sportswear due to its marketing strategies that are gradually targeting certain sports franchises around the world.
While Anta is playing the asset monopoly game, LiNing is attempting the long term insinuation of the brand in the customer’s minds globally.
It’s a process that could take decades to work appropriately; however, it could guarantee years of prosperity and worldwide brand awareness if effective.
Xtep is another relevant player in the Chinese market; however, its importance is marginal in the international markets.
For these reasons, LiNing still has an edge over the direct competitors.
In particular, the group is known internationally for its brand and can leverage its distribution for expanding the brand, strongly connected with the Olympics.
Using the franchise monopoly marketing strategy, the company is slowly getting more and more people to know the brand: it’s an excellent recipe for the group’s long-term growth and profitability.
3. Quantitative Analysis
Financial performance
Above is an overview of Li-Ning Company Ltd full year 2018-19-20 income statement. The figures from the balance sheet have been converted in USD for better understanding and comparability at the exchange rate of USD/CNY=6.52. All the numbers, then, are in USD$ thousand.
During the last three years, the firm enhanced its revenue figures, with a 32% growth between 2018 and 2019 and an increase of 4.2% between 2019 and 2020.
The progression of the gross profit figures is encouraging: while in 2018 the percentage of profit on sales amounted to 48%, in 2019 and 2020, it reached 49%.
This, in management’s opinion, is due to the increased economies of scales in the production of raw materials.
A notable detail in the income statement is that the distribution expenses increased less than proportionally, allowing the business to have a higher operating income margin.
The management was able to grow the operating income margin from 7.4% in 2018 to 11.1% in 2019 and 15.2% in 2020.
The Balance sheet figures communicate a healthy expansion. As a reminder, the above figures are in USD$ thousand, and they have been converted from the Chinese Yuan at the rate of USD/CNY=6.52.
Current assets have expanded, mainly due to the growth of cash reserves. Inventories in the balance sheet saw a nice decrease: the company is trying to have the goods move faster. The solution had especially a significant effect on the growth experienced between 2018 and 2019, the year in which Mr Takeshi was appointed as joint-CEO to promote the efficiency of the supply chain.
Li-Ning, consolidated some of its current debt between 2019 and 2020, with clear improvements in the Net Working Capital cycles.
The current composition of the debt structure allows the group led by the “Prince of Gymnastics” to have enough cash to promote marketing strategies and long term growth of the brand.
Valuation
A company valuation’s objective is always to understand the intrinsic value, making consistent assumptions that can be relatively safe in the middle term.
In the case of Li-Ning, a Discounted Cash Flow is, for sure relevant, since the company gives us enough information to try and estimate its future revenue figures, profitability and liquidity.
Let’s go through the assumptions made to build a precise Discounted Cash Flow Analysis.
DCF Analysis
The first step to understanding this company’s future value is forecasting the sales’ figures for the next five years, up until 2025.
The table below is an overview of the forecasts and the assumptions made for Li-Ning’s business evolution. The figures are expressed in thousand $USD (USD/CNY=6.52).
Footwear sales is an essential part of the business of the group. The forecasted increase in sales is 15% for the year 2021 on the year 2020 and then a consolidation between 2021 and 2022 with a rise of 10% and then 5% for the remaining years.
The same growth figures are also assumed for the apparel sales since they moved almost at the same pace during the previous years.
Instead, past years saw a higher growth rate for equipment and other accessories: that is why the forecasted growth of this revenue segment is 20% during this year while decreasing to 15% next year and 10% for the years to come.
The cost of revenues have followed a less than proportional trend during the last three years. This is considered in the assumptions, accounting for a fixed quota of the revenues, diminished by 0.5%.
Then, the gross profit margin should follow the ratios observed during last years, but it should see a slight positive growth year on year.
Also, distribution expenses have seen, especially in the last two years, a decrease: this trend, empowered by the shift to e-commerce sales, is expected to continue.
The other figures have been assumed to keep being at the same ratio level as previous years.
Li-Ning is experiencing organic growth, powered by its strategic investments in becoming a partner of several sports organisations and famous athletes.
Then, the EBIT figures will experience a ramp-up during the next five years, thanks to improved economies of scales and diminished expenses.
After spreading the assumptions, we proceeded to find the correct Cash Flow figures for the next five years, arriving at the FCF.
After years of heavy investment, we see the sweet spot to experience positive FCF around the end of this year. The pandemic will then see an end (hopefully) in Europe and North America, and the global economy will experience a boom in consumption never seen before.
The next step is to come up with the Weighted Average Cost of Capital, which is the synthetic cost of the capital being used in the company, averaged between debt money and equity money. The table below summarises the information used to estimate the correct cost of capital. The debt-equity mix of the company, as of 31st of December 2020, is 40.46%/59.54%.
We used the perpetual growth, the EV/EBITDA multiple and the EV/EBIT multiple methods to determine the Terminal Value.
For the perpetual growth method, a yearly increase of 2% was estimated. If considered that the forecasted inflation rate for the next five years, for China, is 2%, the number can be seen as really conservative.
It has to be pointed out that the EV/EBITDA multiple is at the moment in an “outlier” level, as the current value is 44x. To better understand the real value at which the company could be sold in five years from now, we use instead a 14x multiple, which is an average between the negative figures of the years before 2016 and the extremely positive ones of 2020, and also the value suggested for the apparel industry.
The EV/EBIT multiple considered suitable for this particular industry is 34.19.
The Present Value of Terminal Value has been obtained from the average of the three methods mentioned earlier. The growth in perpetuity method gave a Terminal Value of over USD$ 18.5B, while the EBITDA multiple approach responded with the more conservative value of USD$ 12.5B. The EV/EBIT multiple method, instead, gave a value of over USD$ 22B.
At this point, we also summed the Present Values (discounted to the WACC) for the years 2021-2025.
We added to the Enterprise Value found to non-operating assets, which equate to cash, subtracted debt and other non-equity claims.
The result is an equity value of USD$ 19.5B, equal to 127.3B Chinese Yuan. This is divided by the number of diluted shares outstanding, 2,490,372,519 as of 31st December 2020. The result is an intrinsic price of HKD$ 61/share. The conversion between USD and HKD happened with an exchange rate of USD/HKD= 7.77.
The analysis then identifies Li-Ning Company Limited as correctly by the market.
But that’s not all! Continue to read the analysis to understand what are the risks of investing in this stock right now.
First, let’s see how Li-Ning Company Limited can be categorised using Peter Lynch’s framework.
Peter Lynch company category
Following Peter Lynch’s guidelines, we can categorise Li-Ning as an “Asset Plays”. We believe that the intangible assets of Li-Ning have a really interesting value. It’s not quick money, for sure. But it can represent steady returns over a long series of years.
4. Risks
Global political relations
China doesn’t have precisely the best relations with all the countries worldwide. In particular, the relationship with the US has been complicated by the Trump mandate. The new President of the United States, Joe Biden, is perceived as more peaceful towards the Celestial Kingdom.
However, Biden recently said to be “prepared to act and impose costs” over the Chinese government’s intervention on Hong Kong’s pro-democracy movement and Taiwan’s heightened intimidation.
The European Union is in the middle, mediating between the need for democracy worldwide and trade freedom.
It could be the European Union to help resolve the destructive conflicts between the US and China.
The error here could lay on the US imposing China tariffs and blocking the export of the oriental power, primarily directed to the States. That could lead the US in a prolonged and intense correction phase, together with the EU, both terribly hit from the perpetrating of COVID-19.
Li-Ning stopped a partnership with the Houston Rockets after the NBA team’s General Manager tweeted in support of the 2019-20 Hong Kong Protest.
This could have international consequences on Li-Ning’s ability to sign deals with several filo-US franchises.
Xinjiang tensions
China is currently facing criticism from around the world over its treatment of the Uighur population of Xinjiang. The Uighurs are about 12 million and primarily Muslim, speaking their own language, similar to Turkish.
Sources claim that China is committing “genocide and crimes against humanity”, and reporters from BBC say to have seen a “total surveillance state”.
Satellite images, then, serve as a testimony of a growing development of suspected internment camps where Uighurs are said to be locked up to help offer cheap labour cost to Xinjiang’s massive cotton industry.
The world is requesting answers from China and Xi Jinping is taking time.
As a company that employs cotton from the Xinjiang area and repeatedly expressed its support to China’s politics, Li-Ning’s international business could be hindered.
Everything, however, is in the hands of diplomats, and the solution found will tell us the possible outcomes of this problematic matter.
5. Conclusion & Investment Strategies
Li-Ning Company Limited is an interesting company trying to offer the global markets a Chinese choice of sportswear and a third option to the American and European hegemony of Nike and Adidas.
We’ve covered enough our expectations for the company, but we have to sum up the general sentiment on the stock price.
The current price of HKD$ 60/share appears to be correct for the current health status of the company.
However, the risks outlined before are not to be underestimated, and they could endanger Li-Ning’s business and its exposure in the international markets.
From a technical analysis of the stock on the weekly chart, we see the price involved in an uptrend that is slowing down: the share price could reach the 66.15 resistance area, where a correction to the region HKD$ 53-56/share could happen.
On the daily chart, the price action remains relatively bullish.
A possible convergence of the moving averages around the third week of April 2021, together with a long permanence of the price in overbought levels from the first week of March, could determine, as observed earlier, a price correction before resuming a slower growth.
For investors looking to open a position on Li-Ning Company Limited, short term patience is advised until the possibility of a correction has either manifested or faded.
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