EUR 850.00 For Business Accounts Only

Morningstar | We Remain Confident in Anta Despite Muddy Waters’ New Report; Profit Alert Boosts Sentiment

In response to Muddy Waters’ fifth short-selling report, Anta acknowledged its close relationship with one of its many suppliers and distributors, Peng Qingqi, and provided reasonable explanations behind low-single-digit margins generated by Peng’s manufacturing business. Through cherry-picking words used on Peng’s small-scale Tmall store, Muddy Waters presented, perhaps, some of the most unwarranted conclusions so far. We think these increasingly simple-minded conclusions demonstrate either the short seller lacks a basic understanding of how businesses are conducted in China, or the “due diligence based” firm has become too caught up in maintaining its track record.

Our fair value estimate of HKD 55 is unchanged after Anta released preliminary operating figures for the first half of 2019. We view shares of the company as fairly valued ahead of their full interim results in about a month's time.

In part five of its short-selling report, Muddy Waters put forth the idea that Anta shifts costs to Henan Ruili Sporting Goods, a supplier the sportswear company is alleged to control secretly. In rebuttal, Anta management not only denied that it controls the supplier, but also explained that the supplier’s lower margins are because the manufacturer has only been around for a couple of years and is still at an early stage of development. Statements of profit and loss published by Muddy Waters reveal Ruili’s steadily rising operating income margin, from 1.8% in 2016 to 5.6% in 2018. Furthermore, management of Anta also pointed out that an average footwear supplier generates around 7% margin, and the other higher-margin firms cited by Muddy Waters are not proper comparisons due to different business mix. More importantly, Henan Ruili’s CNY 400 million top line represents merely 3.8% of Anta’s 11 billion cost of goods sold, which means even if the company intentionally suppressed Ruili’s margin by 500 basis points, resulted cost-saving would only amount to CNY 22 million, or 0.2% lift to listed company’s gross profit. We see little incentive for Anta to be interested in such a scheme.

Additionally, Muddy Waters does not seem to understand Anta’s Fila distributors can also sell products online and questions the ownership structure of distributors’ e-commerce websites. While we admit that a distributor’s Tmall store should probably avoid describing itself as “self-operated” to avoid confusion, management of Anta suggested that the term was used to convey the fact that these Tmall stores are self-operated by distributors. It is quite clear to us that the short seller has resorted to using the cherry-picking technique to throw mud on Anta.

On the same day, the sportswear company also issued a positive profit alert for the first half, featuring revenue that is up more than 35%, operating profit up more than 50%, and profit to equityholders up more than 25%. We are mostly surprised by the strong operating profit number, although part of the strong performance was driven by a one-off early receipt of government grants. We believe profit to equity shareholders was dragged down by acquisition costs, interest expenses, and Amer’s seasonal losses. Although the market has reacted positively to Anta’s profit alert, we think there are holding off from changing our fair value estimate until more financial information becomes available.