Sportswear makers step up competition in China; local brands feel heat

Fitch Ratings expects the Chinese sportswear industry to expand rapidly over the next five years, but expansion by existing foreign market leaders and new entrants will intensify competition.

As a result, smaller domestic players that have weaker brand recognition and product differentiation are likely to suffer market share erosion. Based on the General Administration of Sports's five-year plan (2016-2020) released in early May, Fitch forecasts the sportswear market in China to grow to about CNY300bn by 2020 from CNY100bn in 2015.

Fitch expects leading foreign sportswear makers to accelerate penetration into lower-tier cities in China to tap new consumers. They will be supported by their strong brand recognition and product offerings across different price tiers. For instance, nearly half of the new stores opened by Adidas in the past five years were located in lower-tier cities. Fitch estimates cities in the third tier and lower form about 50% of the gross sportswear market in China, with the markets expanding healthily. Markets in these cities have many domestic brands participating, and they compete mainly on price.

With rising disposable income and a shift towards more healthy lifestyles, consumers in lower-tier cities may seek more value in brand identity and product differentiation, which are weaknesses of domestic brands. The further penetration into lower-tier cities by foreign leaders and their strong market presence in top-tier cities have bolstered the growth of their Greater China top line in the past quarter of 2016. Adidas's net sales in Greater China in the first three months of 2016 rose 28% yoy, compared with 18% yoy growth for the whole of 2015. Its gross margin increased by 130bp to 57%. Similarly, Nike reported 27% yoy growth in the sales derived from Greater China and 43% yoy growth in EBIT in the three months ended February 2016. As a result, they are allocating more capex in China in 2016.

For instance, Adidas plans EUR750m in global capital expenditure in 2016, compared with EUR513m in 2015, and Fitch expects China to account for a large share of expansion as it has overtaken North America as Adidas's second-largest market in the first quarter of 2016. For Chinese sportswear makers, the increased competition from foreign brands is already starting to slow their order growth from the high double-digit pace in late 2015 to low-to-mid double digits in early 2016.

Fitch expects smaller domestic manufacturers' margins to come under pressure in the next five years due to increasing competition, their limited pricing flexibility to distributors and rising labour costs. As a result, most domestic sportswear makers are either reducing or maintaining capex in 2016. Fitch expects the foreign players to continue to lead the sportswear market in top-tier cities in the next five years. New entrants like Under Armour and larger domestic brands that are retooling their images with higher-end products are also likely to reshape the market structure. Domestic market leader Anta formed a JV with Japan's Descente and Itochu in 2016 to provide high-end professional sportswear. Similarly, 361 Degrees teamed up with One Way, a Finland brand specialising in winter and outdoor sports, to diversify its product portfolio and to grab more market share in high-end winter sports.