China’s Consumers Upgrade to Nike and Adidas

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Yifan Zhang recently splurged on a pair of Nike basketball shoes inspired by his favorite basketball player — Le Bron James. 

The 25-year-old university teacher in Wuhan, a city of 9.7 million, and the capital of the central Chinese province of Hubei, says the shoes cost him nearly double of what he would have paid for a domestic brand. However, he says, he would never have considered China's largest homegrown sportswear brands such as Li Ning and Anta.

"Nowadays in China you do pay attention to other people's opinion of you," says Zhang. "If you choose something like Li Ning and Anta people will say well, this kid is not rich enough to afford brands like Nike and Adidas."

According to estimates from Shanghai-based market research firm, China Markets Research Group, Nike [NKE  85.82    1.46  (+1.73%)] has the largest share of the sportswear market in China with 16 percent, Adidas comes in second with 13 percent, while local brands Li-Ning [2331.HK  8.66    -0.39  (-4.31%)] and Anta [2020.HK  10.42    0.20  (+1.96%)] have around 10 percent and 8 percent, respectively.

Zhang is part of a growing band of consumers who don’t mind spending on foreign sportswear brands. Xiao Wei Zhu, a 31-year-old product manager who lives in Shanghai, says his favorite brands are Adidas and Skechers [SKX  16.11    0.28  (+1.77%)] and he too would never think of buying domestic brands.

"What's taking place right now is you have a shift in consumption, you have more and more Chinese consumers actually trading up, wanting to go to the global brands," says Erwan Rambourg, head of consumer and retail at HSBC Global Research, in Hong Kong.

The bank has predicted continued growth for both Nike and Adidas in China and forecasts an 11 percent gain in Nike shares and a 31 percent rise in Adidas' stocks over the next 12 months, given that Adidas shares have fallen much more steeply from their highs of the year.

China is a key market for both Nike and Adidas, the world's largest and second-largest sportswear-makers respectively. The two firms are the largest foreign players in the country overshadowing Puma and New Balance.

Sales for both companies are increasing around 20 percent annually in Greater China. In fact, 23 percent of Nike's earnings before interest and taxes and 11 percent of its annual revenues now come from there. While Adidas doesn't break up its earnings by geography, Greater China accounts for 9 percent of its annual revenues and the company says China is its biggest source of growth.

But there are dark clouds on the horizon, the biggest of which, is accelerating inflation. Rising wages, input costs and distributors wanting a bigger cut, are just some of the challenges sportswear companies are dealing with. HSBC forecasts that margins at both Nike and Adidas will remain flat in the coming years. It's a phenomenon affecting all the players in China's booming market, says James Roy, senior analyst at China Market Research Group.

Then there's competition from domestic brands, especially the largest players, which in recent years have made big strides in improving quality.

"It would be a mistake to underestimate the progress that Li Ning and Anta have made," says Roy. "They've invested in branding and research and development."

Growth Tapped Out?

Both Nike and Adidas have around 7,000 points of sales in China and analysts worry that they have tapped out growth in China's main urban centers of Beijing and Shanghai.

"It might seem shocking, yes, that they already have over 7,000 points of sale," says HSBC's Rambourg. "But you have to bear in mind that in China... the battle that took place in the first-tier cities is now moving downwards to second- and third-tier cities."

According to Rambourg, Nike and Adidas are giving their distributors bigger margins to incentivize them to take their brands to smaller cities, where domestic brands have been winning because of their value for money proposition. 

"The most interesting thing is what's going to happen in those cities, whether the domestic brands continue to do well," says Roy of China Market Research Group.

That's where consumers like 25-year-old university teacher Zhang come in. Wuhan, where he lives, is considered a tier-2 city. While Zhang says he doesn't wear his new shoes to the classroom because such flashy behavior would be frowned upon, he's already chosen foreign brands over local ones.

Now Nike, Adidas and their shareholders will be hoping they can win over many more like him.

Source:http://www.cnbc.com/id/44449695