CHINA’S TOP-SELLING tennis shoe brand by sales volume, Erke, is now available in as many as 3,251 exclusive sporting goods boutiques.
The Erke chain of boutiques is managed by China Hongxing Sports, a S$1.7-billion market cap company listed on SGX (Oct 2005 IPO: 40 cents).
”Erke wants to be to tennis what Nike is to basketball, what Adidas is to soccer, what Yonex is to badminton,” says CEO Denis Wu in an interview with NextInsight this week.
The sports shoemaker sold Rmb 2 billion worth of sporting footwear, apparel and accessories in FY07. Tennis shoes contributed 18% to footwear sales.
Apparel and accessories gross margins are about 18 percentage points higher than for footwear. Combined, the two segments contributed 34% to top-line.
9% of revenue contribution shifted from footwear in the past financial year to apparel, resulting in overall margin expansion of 4.3 percentage points.
Competitors are domestic brands such as Hong Kong-listed Li Ning and Anta, and SGX-listed China Sports, which owns the Yeli brand.
UOB Kayhian, which has a buy call on the stock at target price S$1.07 (60% upside), believes there is room for China Hongxing to grow margins further.
Reason cited: sporting gear competitors Li Ning and Anta have higher top-line contribution of 58% and 46%, respectively, from apparel and accessories.
Business strategy flows down to bottom line
Does top-notch branding in sporting footwear and apparel translate to better financials? Or does volume matter more?
Top-selling domestic sporting footwear and apparel brand, Li Ning's net margins, at 10.4% (1H07), is merely half that of China Hongxing's 20.4% (FY07).
Li Ning shoes retail at about Rmb 450 a pair.
In comparison, China Hongxing's Erke shoes retail in the mid-tier price category at about Rmb 260 a pair. Its targeted consumers come from households with gross income exceeding Rmb 50,000 a year.
The market leader's gross margins are 48.7% compared to China Hongxing's 41.1%.
Li Ning has a much higher distribution expense ratio of 28.6% compared to China Hongxing's 15.3%, though. This may be because its distribution expense includes advertising expenses, rental of retail stores and renovation cost.
China Hongxing's distribution model does not include store renovation cost. Prior to 2008, it did not include rental.
Laudable FY07 financial report
| Turnover growth | 45% |
| Net profit growth | 94% |
| New retail outlets opened | 601 (up 18%) |
| Per store sales growth | 18% |
| Higher return on advertising dollar | A&P expense-to-sales down 2.1ppt |
| Gross margin improvement across all segments | consolidated figures up 4.3ppt |
"The population for China Hongxing’s target customer is burgeoning," says Mr Wu.
Per capita disposable income of China’s urban population grew 17% in 2007 to Rmb 13,786.
China Hongxing's turnover grew 45% y-o-y, after 601 new Erke boutiques opened last year added 18% to the count in points of sales. Selling prices across all segments increased, as did sales volume.
"We increase selling prices each year," says Mr Wu.
Price increases are introduced in new product models for each season.
120 new shoe designs and 150 new apparel designs were launched during December 2007's trade fair in Fujian, which showcased new models to the company's distributors and retailers.
Sales per store grew 18% to Rmb 629,406.
Net income near-doubled to Rmb 416.5 million, thanks to gross margin improvements and higher return on the advertising dollar.
Gross margins improved 4.3 percentage points to 41.1%. Advertising and promotion expenses to sales ratio fell 2.1 percentage points to 13.9%.
Dividends for FY07 increased 52.9% y-o-y to Rmb 0.0395 per share, compared with Rmb 0.026 in FY06.
Be everywhere when global sporting events happen in China
”FY08-09 are crucial brand building years for us,” says Mr Wu, who is budgeting a 3-percentage point y-o-y rise in A&P expense-to-sales ratio in FY08.
Erke is a prominent sponsor of many sporting events.
It is the official website sponsor of the Chinese Tennis Association. Prominent Chinese tennis players Zheng Jie and Yan Zhi are Erke brand ambassadors.
It also sponsored major tennis tournaments such as the Women’s Tennis Association Tour and the 2007 China Tennis Grand Prix.
Coming up are billboard ads for soccer and basketball games. The company wants to leverage on the popularity of these two sports to increase brand recognition for Erke.
From now till March 2008, basketball fans can watch Yao Ming playing for Houston Rockets and Yi Jianlian playing for Milwaukee Bucks flanked by Erke billboard advertisements.
And until April 2008, soccer fans can watch the Spanish Premier Liga games amidst Erke billboard ads on free-to-air main sports channel CCTV5.
Come August 2008, the North Korean Olympic team compete in sports gear sponsored by Erke.
The company wants to be everywhere when major sporting events that hype up demand happen. It targets at least 600 new outlets a year or 3,850 by end 2008.
It now has over 20 flagship boutiques occupying an area of 250 sq m or more each.
9 of these are in first-tier cities such as Guangzhou, Beijing and Tianjin.
Another 100-odd retail outlets are mid-sized boutiques occupying 100-200 sq m each.
The remaining 3,000-odd stores occupy less than 100 sq m each.
Other than the 2008 Bejing Olympics, there is 2010’s Shanghai Expo and Asian Games at Guangzhou coming up. Hot on the heels of these events will be the World University Games to be held in Shenzhen in 2011.
The company plans to quadruple the number of mid-sized Erke boutiques to 420 by adding 320 outlets of about 164 sq m each in prime locations of second-tier PRC cities.
Rmb 2.3 billion war chest to fund brand augmentation, production and distribution
China’s soaring consumer economy is resulting in fierce competition for prime retail space: rentals are increasing at 20%-30% a year to an estimated Rmb 1,100 to Rmb 1,200 per sq m in FY08.
Renovation and rental had, in the past, been borne by distributors who operate China Hongxing’s 3,251 franchised Erke retail outlets.
To ensure soaring rentals do not hamper its aggressive growth plans, China Hongxing wants to pay the leases of 420 mid-sized Erke boutiques and sub-let them with subsidy to distributors in 2008.
Some Rmb 1 billion has been allocated for this, funded by its recent placement of 400 million shares at S$1.18 per share.
Another Rmb 500 million will be used in advertising and promotion to augment China Hongxing Sports’ Erke brand presence.
Aware of the brand image created by the facade and interior decor of retail outlets, the management is going to spend some Rmb 200 million on 4th generation boutiques, as well as refurbish or relocate 2,000 older Erke stores.
To cope with the rise in demand, its fourth plant – costing Rmb 250 million – will add 6 million pairs of shoe capacity to reach a total of 23.9 million pairs by end 2008.
Despite the soaring labor and material costs, the company prefers in-house manufacturing. Advantages include a shorter production cycle and agility in responding to fashion trends for sporting goods.
Repeat orders on a particular model only take 20 days to produce in-house, and new orders 30 days, compared to 45 days or more when outsourced.
Another advantage of in-house production is control over footwear quality, which is easily discerned by customers.
90% of Erke shoes are manufactured in-house while production for all apparel and accessories are outsourced.
Rmb 100 million is for 4 logistics centers. The first one in Beijing (northern China) is newly operational. Guangzhou (south), Nanjing (east) and Xi'an (west) are next.
Looks like the company is ready to take on China's sports gear scene with a storm.
