September 21, 2011 / 4:13 AM / in 6 years

Analysis: Nike, Adidas trounce China sportswear players

<p>Nike shoes are displayed at a Niketown store in Beverly Hills, California, March 16, 2010.Lucy Nicholson</p>

SHENZHEN/HONG KONG (Reuters) - Drawn by a handwritten notice, a handful of customers sift through stacks of sports shoes and rows of clothes at a Li Ning discount outlet in China's boom town of Shenzhen on a Sunday afternoon.

"Last day! Enjoy 50-55 percent discount on all goods. Buy three, get another 10 percent off," the note read.

A few yards away, on the same floor of the giant shopping complex, another Li Ning retail store looks empty. The brightly lit Nike and Adidas outlets are busier, with youngsters and teenagers trying on sneakers and garments.

"Nike and Adidas products are very good," grumbles a Li Ning store employee, declining to be identified. "The materials they use, the soles and the designs are much better than ours."

After years of breakneck expansion, local brands such as Li Ning and China Dongxiang (Group) Co Ltd are grappling with shrinking margins, slowing sales growth and mounting inventories of outdated products, threatening the sector.

While the Chinese brands struggle, Nike Inc and Adidas, armed with heavy investment in research and development plus marketing expertise, are gaining market share in the world's second-largest economy.

In the sportswear industry's battle for China's booming consumer market, the situation is bad and getting worse for the home grown retailers.

China's fashion apparel market, dominated by sportswear brands and local casual clothing brands, is expected to triple in size to more than 1.3 trillion yuan ($201.3 billion) in the next 10 years, Boston Consulting Group said in a report.

Raising the stakes further, foreign companies are accelerating their expansion into the country's smaller cities, the traditional stronghold of local brands, with products specifically tailored to target consumers in those cities.

Adding to pressure on the Chinese companies, industry experts say it's too early for any of the local retailers to be saved by a takeover or a private equity purchase.

"There needs to be more pain before we see a shake-up in the sector," said George Lin, head of Asia-Pacific consumer, retail and healthcare investment banking for Credit Suisse.

Struggling with rising costs for labor, raw materials, rent, and advertising and promotion, Li Ning and Dong Xiang posted 50 percent and 71 percent falls in first-half earnings, respectively.

Shares of the two companies have plunged more than 60 percent in the past year, while shares of local rivals ANTA Sports Products Ltd, Peak Sport Products Co Ltd, Xtep International Holdings Ltd and 361 Degrees International Ltd are down 30-50 percent.

These listed sportswear companies, together with Nike and Adidas, account for 80 percent of the domestic market.

Li Ning, whose founder and chairman won three gold medals as a gymnast at the 1984 Los Angeles Olympic Games, has been attempting to cut the number of distributors and shut inefficient retail outlets, while opening more self-operated stores -- a move that may improve branding but also means increased costs.

Adidas aims to unseat Li Ning -- the country's No.2 sportswear maker with a one-third share of the market after Nike -- this year, targeting double-digit growth in China over the next five years and planning to expand coverage to 1,400 cities from 550.

"Local brands will lose more market share to imported brands over the next 12 months as the former struggle with inventory issues, while the latter benefit from consumers trading up," HSBC said in a research report this month.

In June, Nike raised its global sales forecast, betting that strong demand in China and Brazil, and price rises would help it outpace rising costs. In Greater China, Nike topped $2 billion in annual revenue, double 2007's level.

EARNINGS DAMAGE

Capitalizing on annual sportswear demand growth of about 30 percent, more Chinese sportswear companies, including leading indoor sportswear company Hosa International Ltd, are lining up to sell shares in Hong Kong.

But pricing competition is set to intensify as domestic players scramble to dump inventories, sharpen their branding focus and scale back distribution networks.

Domestic sportswear sellers are getting further squeezed by global brands expanding aggressively in both the high-end and low-end segments.

Discounts from global brands are a boon to China's Belle International Holdings Ltd, a strategic partner of Nike and Adidas, which accounts for more than 80 percent of its sportswear sales.

Belle, the country's largest shoe retailer with more than 10,000 outlets, also distributes Converse, Kappa, Puma, Reebok, Li-Ning and Mizuno branded sport shoes.

Those discounts will only add to the challenges of local players.

"With Nike and Adidas introducing lower priced products, it remains to be seen whether fans of domestic brands will maintain their loyalty," the HSBC report said. "This could well become a case of 'survival of the fittest', with some getting hurt if not disappearing along the way."

Editing by Chris Lewis, Anshuman Daga and Michael Flaherty

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