Xtep International: One Step Ahead

Sports equipment has outperformed the overall retail industry, driven by the increase in public participation and the Olympic cycle.

The strong domestic demand is the confidence for sports brands, including Xtep, to grow against the trend.

Xtep, which has established an absolute advantage in the running segment, has two future highlights: first, to continue to consolidate its advantage in the running segment, and second, to unleash the potential of new brand operations.

Xtep International (01368.HK) has seen its net profit increase from HKD 576 million in 2008 to HKD 1.136 billion in 2023 since its listing 15 years ago, with an annual growth rate of about 4.6%.

Its market value has increased from HKD 8.9 billion to HKD 13.46 billion, with a cumulative increase of 51.2% and an annual increase of less than 3%.

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The price-to-earnings ratio has dropped from 17.1 times to about 11 times.

The company has paid out about HKD 8.9 billion in cash dividends, with a dividend payout ratio of 67.9%.

The cash dividends have exceeded twice the total amount of funds raised, bringing good returns to investors.

From the perspective of performance and stock price, the company's historical returns are not particularly outstanding.

However, looking at it in stages, Xtep's performance is commendable.

Historically, the company's development can be divided into three stages.

From 2005 to 2011, it was the golden decade for the development of domestic brand clothing.

Xtep brand was founded in 2001, initially focusing on fashion sports equipment.

During this stage, with the help of the Beijing Olympics and successfully going public in Hong Kong, the company expanded rapidly, with the number of stores increasing from 739 to 7,596, and both revenue and net profit grew rapidly, with an annual growth rate of 63% and 51% respectively.

From 2012 to 2017, the entire industry fell into an inventory crisis.

The company began to reduce orders, reduce stores, integrate distribution channels, and increase discounts in the short term to reduce inventory.

The number of stores continued to decline to 6,000 by 2017.

In 2015, the company began to strategically transform, focusing on running sports, establishing a sports science and engineering laboratory, and deeply cultivating marathon events, transforming towards functional sports equipment.

At the same time, a flat distribution channel was established, with 60% of the stores directly operated by Xtep's exclusive general agent, strengthening the control of the retail channel.

During this stage, both revenue and net profit continued to decline, with an annual growth rate of -1.4% and -12% respectively.

Since 2018, the company has completed its three-year reform plan in 2018, with improved store efficiency, increased retail discount rate, and reduced inventory.

The revenue in that year was 6.4 billion yuan, setting a historical record.

Since 2019, the brand has entered a diversified stage, forming a brand matrix of mass sports, fashion sports, and professional sports.

During this stage, the annual growth rate of revenue and net profit was 18.9% and 15% respectively.

The company has entered a period of rapid growth again.

To this day, in 2023, the company's revenue and net profit attributable to the parent company were 14.345 billion yuan and 1.03 billion yuan respectively, both setting historical records.

Its business can be divided into three operating segments according to the nature of the brand, namely mass sports, with the representative brand being Xtep; fashion sports segment, with the representative brand being K-Swiss and Palladium; professional sports segment, with the representative brand being Saucony and Merrell.

The revenue proportion of the three segments is 83.3%, 11.2%, and 5.5%, respectively, and the gross profit margin is 42.0%, 44.8%, and 40.0% respectively.

From 2021 to 2023, the company achieved excellent operating results, especially in the context of the impact of the COVID-19 pandemic, slowing macroeconomic growth, and pressure on the consumer market, which is even more commendable.

In 2024, a sports year, a series of important sports events will be held worldwide, attracting the attention of sports fans and greatly stimulating the enthusiasm for sports equipment consumption.

Driven by the enthusiasm for sports consumption, the market size of China's sportswear industry has continued to expand in recent years.

According to Euromonitor statistics, from 2013 to 2022, the annual compound growth rate of sportswear in China was 11.6%, and at the same time, the per capita expenditure on sportswear increased from $16 to $38.3, with an annual growth rate of 10.3%.

However, compared with developed countries, China's per capita expenditure on sportswear is only 1/10 of that in the United States, 1/3 in South Korea, and 1/2 in Japan, and there is still a large room for improvement.

In addition, the current participation rate of Chinese residents in sports activities is about 37.2%, which is still a large gap compared with 75.6% in the United States.

According to the data of the National Bureau of Statistics, from January to June 2024, the retail sales of sports and entertainment goods increased by 11.2% year-on-year, showing a good trend.

In contrast, during the same period, the retail sales of clothing goods in units above the designated size in China increased by 0.8% year-on-year, which slowed down by 14.7 percentage points compared with the same period in 2023.

The current consumption recovery trend generally shows the characteristics of "K-shaped recovery".

Some industries with potential and companies with operational advantages are contributing more to the recovery momentum, while some stagnant companies are giving up more market share.

Specifically, in the sportswear industry, it can be observed that the market pattern has been rewritten in recent years, and the old and new forces are beginning to change.

In the past decade, the pattern of China's sportswear industry has shown two distinct characteristics: first, the concentration has continued to increase, and second, the rise and fall of international and domestic companies.

In terms of concentration, the share of the top ten companies in the industry increased from about 68% in 2013 to about 85.5% in 2022.

The share changes of domestic and international companies have gone through two stages, from 2013 to 2020, the share of domestic companies showed a downward trend, and in 2020 it decreased by 6.0 percentage points compared with 2013 to 36.4%, from 2020 to 2022, benefiting from the rise of the national trend, the share of domestic companies increased rapidly, and in 2022 it increased by 9.6 percentage points compared with 2020 to 46.0%.

If looking from the perspective of brand share, from 2020 to 2022, foreign brands have been defeated, and domestic brands have made a long drive, Anta increased from 8.6% to 11%, only one step away from the second place Adidas, Li Ning increased from 6.8% to 10.4%, and Xtep increased from 4.6% to 6.3%.

Domestic sportswear companies also show differentiated development characteristics, each with its own advantages.

Taking the top four companies in the industry as an example, the industry leader Anta implements a strategy of "single focus, multi-brand, globalization" to achieve the coordinated development of multiple brands; Li Ning is the development strategy of "single brand, multi-category, multi-channel", leading the "new national trend" marketing; Xtep focuses on the running segment, sponsors a large number of marathon events, and leads the industry in running shoes; and 361 degrees mainly targets the mass market, providing high cost-effective products.

Among them, Xtep continues to cultivate the running field, and enough strategic focus and long-termism have borne fruit.

In 2015, Xtep carried out strategic changes, proposing to "return to sports from fashion sports", and began to focus on the running field.

In this regard, Chairman Ding Shuibo once said: "You can run alone at home, or you can run with tens of thousands of people together, it has no restrictions on the venue, and there is no age threshold, I am optimistic about China's running market."

The development path of Nike, the leader in the global sportswear field, started from the running segment, and gradually developed into the leader of the sports industry through a series of acquisitions and integrations.

Now, this is also the development logic of Xtep.

The 2023 China Marathon Big Data Report shows that the wearing rate of Xtep running shoes is as high as 27.2%, surpassing well-known brands such as Nike and Li Ning, and becoming the first in the wearing rate of running shoes in domestic marathon events.

Not only that, but the company's brand Saucony also ranks third with a wearing rate of 8%.

Xtep has established an absolute advantage in the running segment.

The mid-term report has achieved excellent results.

On August 20, the company announced the mid-term performance as of June 30, 2024, and once again achieved a dazzling report card.

In the first half of the year, the company's revenue increased by 10.4% to 7.203 billion yuan, the net profit attributable to the parent company increased by 13.0% to 752 million yuan, and the net cash inflow from operating activities increased by 211.6% to 826 million yuan.

Among the top three domestic sports brands, the industry leader Anta achieved a year-on-year increase in revenue of 13.8%, and Li Ning's revenue growth rate was 2.3%, and Xtep is catching up with the industry leader.

Looking at the brand, the revenue of the main brand Xtep increased by 6.6% to 5.789 billion yuan, accounting for 80.4% of the total revenue, and the basic plate is still stable.

Xtep explained that the increase is mainly due to the good performance of online channels.

The revenue of the professional sports part increased by 72.2% to 593 million yuan, and the revenue proportion increased to 8.2%.

The driving factor is the double-digit same-store growth and stable online performance.

Whether it is the good performance of online channels or the same-store growth, it essentially reflects the pull of retail terminal sales, not the growth brought by channel distribution, which is a healthy and sustainable growth, and also a manifestation of product strength.

This is also reflected in the number of stores announced in the semi-annual report.

As of June 3, there are a total of 6,578 adult brand stores of Xtep in mainland China and overseas, an increase of only 7 from the previous quarter.

Since 2018, the increase in the number of Xtep stores has been slow, on the one hand, the channel is more inclined to online, and on the other hand, the continuous promotion of store upgrades, which has been upgraded to the ninth generation so far.

A larger single store area can accommodate a more complete range of products, and with the upgraded visual marketing, it can increase the average customer unit price and store efficiency, and is also conducive to the upgrade of the brand image.

Looking at the product division, shoes increased by 14.3% to 4.45 billion yuan, and clothing increased by 4.3% to 2.605 billion yuan, reflecting Xtep's focus on running shoes, clear strategy and significant effect.

While the revenue increased by double digits, the cost only increased by 4.4%, the gross profit increased by 18.5% to 3.314 billion yuan, and the gross profit margin increased by 3.1 percentage points to 46%.Here is the translation of the provided text into English: According to the semi-annual report standards, for the five years from 2020 to 2024, the gross profit margins in the first half of each year were 40.5%, 41.8%, 42.0%, 42.9%, and 46.0%, respectively.

The continuous increase in gross profit margins implies that the company's product prices have been rising over the past five years, with a higher proportion of high-gross-profit products in the product mix.

Specifically, on one hand, the gross profit margin of the basic mass sports division has improved, with the main brand XTEP's gross profit margin increasing from 40.5% in the first half of 2020 to the current 43.9%.

On the other hand, there has been an adjustment in the business structure; the professional sports division, which had a gross margin of less than 0.5% in the first half of 2020, has increased to the current 8.2%.

Amidst the current trend of consumer confidence needing improvement and consumer spending under pressure, sports equipment has performed better than the overall retail industry, driven by increased public participation and the Olympic cycle.

The strong domestic demand is the confidence behind the counter-trend growth of sports brands, including XTEP.

XTEP's sales expenses in the first half of the year increased by 12.05% to 1.692 billion yuan, slightly higher than the revenue growth rate, mainly due to increased marketing and promotional expenses, as well as higher platform fees related to online channels.

Additionally, due to the acquisition of all equity interests in the Saucony and Merrell joint ventures, the sales expenses of the professional sports division have been consolidated.

Administrative expenses increased by 26.1% to 802 million yuan, primarily due to increased employee costs resulting from the acquisition of Saucony and Merrell joint ventures.

The overall cost rate increased from 32.9% in 2023 to 34.6% in the current period, an increase of 1.7 percentage points, with the one-time impact of the acquisition being greater, while revenue growth did not lead to more operational expenses, indicating good quality growth.

It is worth noting that the company's operating capital turnover days in this period were 90 days, slightly higher than the 88 days in the same period last year, and this indicator was 64 days at the end of the 2021 fiscal year.

This indicator reflects the time it takes for the company to convert operating capital into sales revenue.

Apart from liquidity issues, the longer the operating capital turnover days, the lower the operational efficiency.

An increase in the operating capital turnover days can be caused by a decrease in accounts payable turnover days, an increase in accounts receivable turnover days, and an increase in inventory turnover days, all of which can occur when revenue increases.

Compared to the end of 2021, XTEP's operating capital turnover days have increased significantly, mainly due to a decrease in accounts payable turnover days and an increase in inventory turnover days.

For footwear and apparel brands, a decrease in accounts payable turnover days can also be a reflection of competitiveness.

Often, downstream contract manufacturing enterprises have slim profits, with XTEP's footwear business outsourcing accounting for 67%, and apparel business outsourcing accounting for 91%.

Providing a shorter payment cycle to downstream contract manufacturers helps to better manage the supply chain and obtain stable, long-lasting, and quality-assured services.

An increase in inventory turnover days does not necessarily indicate a decrease in the company's operational efficiency.

It can be seen that the company's inventory turnover days were the lowest in 2016 (51 days), which was at the end of the industry's inventory reduction cycle.

As the industry entered a new channel restocking cycle from 2017, the company's inventory turnover days increased to above 75 days, and the relatively higher figures in the past two years are due to high sales growth and an increase in the proportion of offline self-operated stores.

In summary, inventory turnover rate is an important operational indicator for the company and requires continuous tracking and observation by investors.

Divesting KP to optimize the business structure, another event worth noting for shareholders in the 2024 semi-annual report is the company's announcement of the strategic divestment of the fashion sports brands K-Swiss and Palladium (KP), focusing on developing high-profit brands in the business portfolio.

From a capital allocation perspective, divesting continuously loss-making businesses is a rational choice in the current environment.

I believe this is a reflection of the management's rationality and strategic focus, which is conducive to the improvement of shareholder interests.

XTEP launched a multi-brand strategy in 2019, attempting to create new growth points, dividing products into three categories: mass sports, professional sports, and fashion sports.

The main brand XTEP is defined as targeting the mass market.

In March of the same year, a joint venture with Wolverine was established to operate the Saucony and Merrell brands, targeting high-function and high-performance professional users.

In August of the same year, the K-Swiss and Palladium brands were acquired, targeting high-end users pursuing fashion and comfort, with distribution networks covering first-tier cities in China, as well as overseas regions such as North America, Europe, and Asia-Pacific.

The two newly acquired business divisions have taken completely different directions after nearly four years of operation.

From 2019 to 2023, the revenue of the fashion sports division increased from 466 million yuan to 1.603 billion yuan, with an annualized growth rate of 36.3%.

However, the operating profit has been negative year after year, and the operating profit margin has shown a downward trend.

The larger the revenue scale, the greater the loss, which has lowered the company's overall profit margin.

In contrast, the professional sports division has performed well, with revenue increasing from 100 million yuan to 796 million yuan, and the pre-tax profit has turned from loss to profit, entering a virtuous development track.

According to the company's explanation, the poor operating results of the fashion sports business are due to the drag of overseas business.

Initially affected by the pandemic, supply chain disruptions, and port congestion, it has recently been affected by inflation and geopolitical tensions in Europe and America, with overseas business continuing to perform weakly.

In fact, the fashion sports field is highly competitive, with Anta and Li-Ning having long-term operations and traditional advantages in this area, which is their comfort zone.

Although the K-Swiss and Palladium brands are long-standing internationally renowned brands, they are not very present in the domestic market, and it takes a long-term and substantial investment to cultivate consumer awareness.

It is extremely difficult to operate successfully in the short term.

Moreover, XTEP's strategic focus is on the running sports market, and the fashion sports brands do not have strong synergy with the company's user mindset.

After divesting KP, the company currently focuses on operating the three major brands: XTEP, Saucony, and Merrell.

Among them, XTEP targets the mass market, Saucony serves high-end customers, and Merrell focuses on trail running and outdoor sports.

All three brands are positioned around the running field, with a clear structure and complete layout.

Subsequently, the company can allocate more resources to Saucony and Merrell, expand product lines, increase the number of stores, and increase marketing investment, all of which can produce synergistic effects to further amplify the company's advantages in the running field.

The company spent $260 million to acquire the K-Swiss and Palladium brands in 2019, and the cumulative pre-tax loss exceeded $100 million over four years.

In this divestment, the company signed an agreement with the controlling shareholder Ding Shuibo and its family company to sell based on the book value of KP Global as of March 31, 2024, with a transaction price of $150 million, resulting in a book loss of more than 40% in this acquisition.

However, on the positive side, after completing the divestment, it is estimated that the company can reduce pre-tax losses by 180 million yuan per year, increasing the company's pre-tax profit by about 10%.

In addition, after KP is divested from the listed company, it will continue to be operated by Ding Shuibo's family company, which is expected to focus more on overseas and high-end markets.

KP Global also issued convertible bonds worth $154 million with a term of 8 years to XTEP to offset the capital expenditures incurred since the acquisition by XTEP, and XTEP has the right to convert it into a 30% equity stake in KP within the next 8 years.

In other words, by divesting KP, XTEP shareholders not only get back the transaction price of $150 million but also obtain $154 million in bonds, with the right to convert shares in the future.

XTEP shareholders did not incur a substantial loss, and most of the losses were borne by Ding Shuibo's family company.

If KP's business operations improve in the future, XTEP shareholders also have the right to share its results, which reflects the rational and generous side of the controlling shareholders in capital operations, and also indicates that the controlling shareholders still have confidence in KP's business.

The future growth space is broad.

I believe the future prospects of XTEP can be observed from two aspects: first, continue to consolidate advantages in the running sub-segment, and second, the potential of new brand operations.

Looking at the growth of the running track, the future growth potential is still very strong.

On one hand, the number of running events is increasing year by year, which will drive the consumption of running shoes.

Before the pandemic, running events had already risen rapidly, with the number of running events growing at an annualized rate of 77.7% from 2011 to 2019, among which certified events increased from 22 to 357, and large-scale events increased from 0 to 1828.

Marathons have resumed since 2022, and the scale of future events is bound to rebound quickly.

On the other hand, the increasing participation of the public in running in recent years will also drive the consumption of running shoes.

According to data from the domestic online running platform Yue Pao Circle APP, the number of daily active users increased from 1.81 million in 2019 to 2.2 million in 2021.

As mentioned earlier, XTEP has achieved excellent results in various marathon events, with the highest wear rate and has established a strong product power in the running shoe category.

Relying on professional product power, XTEP uses professional running shoes as a link to form the XTEP Running Tribe offline running club, establishing an online + offline running closed-loop ecosystem.

As of the first half of 2024, XTEP has 67 running clubs across the country, with 2.1 million members and more than 5,700 running groups.

The track has a broad prospect, and XTEP's shoe products are strong and highly user-sticky, but they have a more advantageous cost-performance ratio compared to peers.

As the company's financial report mentioned, with the slowdown of macroeconomic growth, consumers pay more attention to prices, and XTEP's main brand has core competitiveness in providing high cost-performance products.

This can be seen by comparing XTEP's flagship products with those of other brands.

Flagship running shoes are priced at 999-1299 yuan, while other brands are generally priced at 999-2299 yuan; mass running shoes are priced at 299-499 yuan, while other brands are generally priced at 599-999 yuan.

In the current environment, XTEP faces less pressure for discount promotions than its peers, and if the consumer environment improves in the future, XTEP will have more room for price increases.

Please note that the translation provided is quite lengthy and complex due to the detailed financial and operational data included in the original text.Next, let's look at the operation of the new brand.

In December 2023, Xtep acquired the equity held by the joint venture company where Saucony is involved for $61 million, and also acquired 40% ownership rights in Saucony's business in China.

Currently, Xtep owns 100% of Saucony's business in China.

Unlike the main brand Xtep, Saucony focuses on functionality and targets first and second-tier cities.

Similar to Anta's acquisition of FILA, by operating a high-end brand to enter the consumer group in high-end cities, a new growth curve is created.

It took FILA 5 years to turn from loss to profit, while Saucony only took 4 years, and Xtep's operation is undoubtedly successful.

Saucony's positioning is elite runners, which forms a certain complementarity and differentiation from the main brand Xtep that faces the mass sports market.

In terms of resources, both parties have already achieved certain effects in sharing from running clubs to research and development centers, brand resources, and marathon events.

Currently, Saucony's revenue scale is still small, but the market space is vast.

In the future, Xtep will continue to delve into the running track, use the mass brand to enhance the overall revenue ceiling of the company, and use the new brand to drive high-profit business, and there is still a broad space for growth.