Clarification on market concerns & introduction of 5-year target
Li Ning (2331.HK) – Clarification on market concerns & introduction of 5-year target
• Li Ning (2331.HK) held an operational update last night to address market concerns on (i) channel inventory, (ii) potential steepening of retail discounts beyond 4Q23, and (iii) impact on sales from unauthorized sales by distributors
• The Company also set a five-year target to achieve double-digit top-line CAGR to reach RMB 50 billion in sales by 2028 , driven by (i) recovery in store productivity, (ii) an increase in IP and product offering in core categories including running and basketball, and (iii) further penetration into lower-tier cities and the overseas market.
• We are encouraged to see Li Ning’s ambitions to continually innovate and compete in the market. We expect more time is needed to assess how well Li Ning performs in achieving such goals. Our last rating stands at a BUY, with TP at HK$37.
Inventory level is under control. Li Ning (2331.HK) held an analysts’ call to extensively address market concerns on (i) channel inventory, (ii) the potential steepening of retail discounts beyond 4Q23, and (iii) unauthorized sales by distributors impacting sales. During the call, management emphasized that 3Q23 was primarily dragged by a slowdown in the e-commerce and wholesale channels, while gross profit margin pressure is due to a weaker than expected sell-through rate, particularly in the e-commerce channel. This has resulted in a cut in guidance, with an earnings decline expected in 2H23 (previous: high-single to double-digit yoy growth). The Company has taken proactive steps in slowing down its sell-in to specific channel to ease inventory pressure. Li Ning reiterated that its channel inventory remains at a very healthy level and is expected to see further improvement by the end of 4Q23.
Financial target established. Li Ning also took the opportunity to introduce a medium-term target to achieve a 5-year CAGR of double-digit top-line growth to reach RMB 50 billion in sales by 2028 This will be driven by (1) expanding product categories, (2) increasing penetration into lower-tier cities and the overseas market, and (3) cultivating new channels, with expansion in the overseas market. We are encouraged to see Li Ning’s ambitions to continually innovate and compete in the market. We expect more time is needed to see how well Li Ning can achieve such goals. Our last rating stood at a BUY, with target price at HK$37. The stock is trading at 15x/13x FY23E/FY24E PE, which we deem attractive levels.
Key Summary:
Introductory statement. The Company held a call to extensively address market concerns on high inventory turnover as well as market speculations of the CEO or CFO leaving the Company, which are untrue. Q3 2023 operating data indeed fell short of expectations. Revenue growth was weaker than expected, mainly dragged by e-commerce and the wholesale channels. The e-commerce channel accounted for at least c.40% of the shortfall. Secondly, the wholesale channel’s sell-through was weaker than expected; hence Li Ning has slowed down the sell-in rate. This accounted for 20% of the shortfall. Lastly, Li Ning 1990 also required more time for restructuring and made up part of the shortfall. As for the gross profit margin, the wholesale margin remained stable, while the DTC margin saw an improvement year-over-year, and the e-commerce gross profit margin was weaker than expected. However, due to a weaker than expected sell-through rate, this has resulted in margin pressure in 2H23.
Inventory under control. The Company emphasized that its inventory level is controllable and healthy. At the moment, the Company’s wholesale channel inventory comprises mainly new products; hence they are not under pressure to raise discounts. Overall, distributors’ inventory turnover should be around 4x, which is at a highly healthy level. Selected distributors have inventory turnover of 5x, but no more than 6x.
Tackling unauthorized sales by distributors. The Company has been targeting unauthorized sales since last year. However, the scale of the problem remains at a controllable level. Li Ning will continue to strategize to control this through stricter supervision and systematic controls to ensure price stability, especially for their core products.
Introducing financial targets. In the long term, Li Ning hopes to achieve double-digit top-line CAGR to reach RMB50b in sales. Over the next three years, the Company hopes to (1) expand its product categories, (2) increase penetration into lower-tier cities and the overseas market, and (3) cultivate new channels, with expansion in the overseas market.
To expand its existing categories as well as cultivate new ones. The Company believes Li Ning running shows promising potential ahead with professional and technological innovation to drive the structural upgrade of the category’s material. Secondly, the Company needs to cement its market share in the core product matrix, including Li-Ning’s ultra-light, flexible, Challenge series. Next, the Company hopes to expand into new categories, such as trail running shoes with technology platforms to support this category. Another core category includes basketball, where Li Ning hopes to become the no.1 basketball brand with a fuller price range ahead. The Company aims to enrich its lower price category to extend such products to lower-tier cities. In its leisure category, Li Ning 1990, the Company hopes to expand its consumer audience and be considered as a high-quality, elegant, high-end brand with a large age range. They would also look to expand into outdoor women’s wear. As for the Li Ning brand, the Company hopes to put more emphasis on Li Ning teenagers to extend its product offering to this age group.
Penetration into lower-tier cities and overseas market. The Company has made good progress in higher-tier cities, with white space reflected in lower-tier cities. The Company will look to introduce products specific for lower-tier cities.
New channel cultivation. Li Ning hopes to expand beyond large-format stores to tourist attractions, communities, campuses, transportation hubs, and other locations with a higher concentration of consumers, introducing newer types of store layouts to attract consumers. The Company also hopes to expand in the overseas market, with Hong Kong as a starting point.