Li Ning: Consider Both Growth And Margins

seekingalpha10-04

I maintain a Hold rating for Li Ning, which is reflective of a neutral view on its growth and profitability prospects.Li Ning's revenue growth outlook is positive, driven by a potential economic ...

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Following an assessment of Li Ning's growth outlook and profitability prospects, I continue to have a Neutral view of LNNGF. The focus of the prior April 27, 2024 write-up was Li Ning's financial and operating disclosures for the first quarter of the current year. The company's shares are traded on the OTC (Over-The-Counter) market and the Hong Kong equity market. Li Ning's OTC shares and Hong Kong-listed shares boasted average daily trading values of $1.4 million and $80 million, respectively, in the last three months. Investors can buy and sell Li Ning's shares listed on the Stock Exchange of Hong Kong with US brokerages like Interactive Brokers or Hong Kong securities firms like Boom Securities. Positive On Growth Prospects Li Ning's top-line growth outlook has improved, taking into account recent developments. LNNGF will benefit from a potential recovery in sportswear apparel demand in China in the scenario that the country's economy and consumer sentiment get better. A recent September 27 Seeking Alpha News article noted that China's \"leaders pledged action to ensure that annual economic targets are met.\" Citigroup's (C) economists subsequently published a report (not publicly available) on September 30 titled \"Ten Questions On Stimulus\" suggesting that the Chinese government could possibly introduce \"consumer vouchers, cash handouts, tax cuts, and employment support\" measures to boost China's consumer sector. The local government in Shanghai has announced plans to roll out \"consumer vouchers\" worth RMB 500 million, and similar moves to strengthen consumer confidence might be implemented in other Chinese cities soon. Li Ning's revenue growth in local currency or RMB terms slowed from +7.0% in full-year fiscal 2023 to +2.3% YoY for 1H 2024 as per its 2024 interim results announcement. At the company's 1H 2024 analyst briefing in mid-August, Li Ning mentioned that it is facing the \"challenge of weak consumer demand\" and observed that China's \"consumption environment is not as good as expected.\" This implies that LNNGF's top-line growth moderation in 1H 2024 was driven to a large extent by poor consumer sentiment in its home market, China. There is a reasonably high probability of Li Ning's revenue growth accelerating in the future, if China does roll out relevant initiatives to improve Chinese consumer confidence. On the other hand, Li Ning's future top-line performance might also benefit from its competitor Nike's (NKE) woes. Nike's revenue derived from the Greater China region decreased by -4% YoY in Q1 FY 2025 (YE May 31). Nike revealed at its latest first quarter earnings call on October 1 that the company is facing an issue relating to \"elevated inventories\" in the Chinese market. In contrast, Li Ning disclosed at the company's 2024 interim analyst call that its channel inventories increased by a \"mid-single digit\" percentage YoY in 1H 2024 and are \"at a healthy level.\" In my opinion, Li Ning has a good chance of grabbing market share from Nike by virtue of being in a better position with regard to inventory health. The market is currently anticipating that Li Ning's top-line growth will moderate further to +1.6% YoY for 2H 2024. Taking into account China's renewed focus on tackling the economy and Nike's challenges, I think that LNNGF's actual 2H 2024 revenue will surprise on the upside. Negative On Margin Outlook In contrast with my favorable view of the company's growth prospects, I am concerned about Li Ning's profitability outlook. LNNGF's normalized net profit margin is forecasted to be 11.1% for full-year FY 2024 based on S&P Capital IQ data, which is on par with the company's actual FY 2023 normalized net margin of 11.0%. My opinion is that it is too optimistic to expect Li Ning to maintain a similar level of profitability this year vis-à-vis last year. Li Ning participated in Goldman Sachs (GS) September 11-12, 2024 investor conference. GS issued a report (not publicly available) titled \"China Conference 2024 - Key Takeaways\" on September 13 highlighting LNNGF's latest management commentary. Firstly, Li Ning shared at the latest GS investor event that its discounts for the wholesale channel widened on a YoY basis between July 2024 and early-September 2024. In the previous section of this article, I noted that Li Ning has managed its inventories well, so it is reasonable that LNNGF will have to make sacrifices in terms of price discounts to keep its inventory level healthy. Secondly, LNNGF has increased investments pertaining to the running and basketball product categories, as per the management's comments at the recent Goldman Sachs conference. At the company's earlier 1H 2024 results briefing, Li Ning had referred to \"running, gyms, badminton, basketball and sports lifestyle\" as its \"five core categories.\" It is the right thing for Li Ning to do to invest in its key product categories, but that comes at a price with regard to profit margins. Thirdly, the company intends to set aside capital to drive its growth in Tier-3 and Tier-4 cities in China, as highlighted in the September 13, 2024, GS report. Notably, a September 26, 2024, McKinsey article indicated that Chinese \"consumer confidence\" is generally better in \"lower-tier cities\" as compared to \"higher-tier cities\" based on the consultancy's surveys. As such, it makes sense for Li Ning to invest more in lower-tier city penetration growth, but these investments will naturally be a drag on short-term profitability. My view is that Li Ning's near-term profit margins might be negatively impacted by wider discounts to keep inventories at a reasonable level, higher marketing costs associated with certain sportswear sub-segments, and further penetration into other parts of China. Closing Thoughts The mixed outlook for Li Ning with regard to revenue growth and profit margin is appropriately reflected in the stock's valuations, which points to a Hold rating. Li Ning's forward P/E and expected earnings growth are both at a similar low-to-mid teens level, and this implies that the stock is trading at a reasonable valuation. As a reference, Li Ning's consensus next twelve months' normalized P/E ratio and the company's consensus FY 2024-2027 normalized EPS CAGR estimate are 13.3 times and +13.4%, respectively according to S&P Capital IQ data.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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