EUR 850.00 For Business Accounts Only

Morningstar | No Mud Will Stick on Anta, Fair Value Maintained At HKD 55

Narrow-moat Anta’s share price has fallen slightly following a series of short-selling reports from Muddy Waters. In three separate reports, Muddy Waters highlights Anta’s relationship with its distributors and an asset disposal transaction as red flags to Anta’s book of business. While we acknowledge there might be a close ties between the brand and its distributors, such a relationship does not post a threat to shareholder capital nor the company’s future returns. While the argument that Anta insiders are selling valuable assets at losses might look compelling on a price/sales basis, the nature of that business and the fact it was running at losses at the time of disposal justified management’s decision to sell. We are maintaining our narrow moat and fair value estimate of HKD 55 for the sportswear group. In our view, the market tends to overreact to short-selling reports. Long-term investors should continue to focus on the value of the company’s brands and market potential.

In its first attack, the short seller accused Anta’s related parties of secretly controlling 27 distributors, squeezing downstream profits to help lift the listed company’s margin ratios. Although Anta did not deny distributor’s margin figures published in Muddy Waters’ report, it claimed those figures are not a fair representation of distributors’ long-term profitability. However, we recognize that relying solely on credit reports is not the most accurate way to gauge the real profitability of some Chinese businesses because there could be other incentives and revenue streams for distributors to keep them running. We do not rule out the possibility that Anta window-dressed its margins by keeping the lower margin distribution business out of the listed entity. However, even if the distribution is kept within Anta, it has no effect on the absolute amounts of profits generated by the listed entity. We think the market is fully aware that Anta shares risks at the distributors, as can be seen by Anta’s involvement in controlling distributors’ inventory levels during 2012. Therefore, even if Muddy Waters’ first accusation that Anta managed some of its distributors is true, such a relationship does not pose additional risks to Anta during an industry downturn.

In the short-sellers' second attack, an asset disposal transaction made in 2008 was questioned. Muddy Waters alleged Anta management of stripping assets for personal benefits. We do not find short-seller’s claim to be credible, given it is valuing a business with one top-line figure. In its rebuttal, Anta said Shanghai Fengxian was losing money at the time of disposal. Based on our knowledge, even the best sportswear distribution business generates much lower returns than a brand management business such as Anta. As a result, the strategic rationale behind 2008 Fengxian disposal makes sense to us.

Moving onto the latest attack, Muddy Waters managed to turn Anta management’s rebuttal against itself, alleging that the independent party’s control of several Fila stores equates to Anta lying about its direct-to-consumer operational model. After following the company for years, we know that a portion of the group’s Fila business runs on a distribution model. We think such a false accusation demonstrates the short-sellers' lack of understanding of the group’s business.

Lastly, Anta reported third-quarter operating performance that is in line with our forecasts. Anta’s core brands, Anta Adults and Kids, recorded the same period sales growth of about 15% in the second quarter. The majority of Anta’s growth and market share gains are from other brands, which delivered a 57% rise in sales during the second quarter. Fila is, again, the center of our attention, where strong growth was driven by rising sales from the Fusion and Kids product lines. Not much news has been released about Amer because reorganizational planning is still underway.