Keep on running

August 31, 2023

Woman tying her running shoes preparing for a run.

In the wake of the unprecedented COVID-19 pandemic, global lifestyles underwent a significant transformation. As travel restrictions and lockdowns became the norm, people found themselves with limited options for entertainment and recreation. Unable to travel, many redirected their discretionary spending towards athleisure wear and comfortable shoes, fueling a boom in the sneaker and sports shoes market.   

As we come out of the pandemic, the surge in leisure goods spending is proving to be unsustainable, especially in the face of a global recession. The footwear industry, like many other sectors, is feeling the pain of this economic downturn.  

Recent earnings reports from major footwear retailers and manufacturers offer insights into this situation. Foot Locker reported its second quarter earnings last week. Revenue was down 10%, gross margins declined by 460 basis points (bps) and the company revised down guidance and paused its dividend. Reasons include weak consumer sentiment, increasing theft and shoplifting of its products and a reset strategy as Nike prioritizes its DTC channel.  

Industry giants like Nike and Adidas have their challenges too. In the quarter ending May 2023, Nike reported revenue growth of 5%. However, gross margins were down by 140 bps due to higher input and freight costs and higher markdowns. Adidas saw its revenue decline by 1% and gross margins deteriorate by 510 bps on higher supply chain costs, deeper discounting and inventory allowances for Yeezy.  

The destocking trend has been observed by one of our holdings, Coats Group PLC (COA LN), which is a world leader in thread manufacturing and structural components for apparel and footwear. It has a 24% global market share in structural components and a 28% market share in threads for the footwear category. With an extensive customer base that includes Nike, Adidas, Puma, VF Corporation and others, Coats offers invaluable insights into the worldwide footwear sector. The destocking trend emerged in the second quarter of 2022 and is expected to take another five months or so to clear the existing inventory. Coats has been in the business for over 200 years and has navigated through various market cycles to be able to anticipate upcoming shifts. This foresight has led it to implement cost-cutting measures during periods of high demand and focus on enhancing profit margins. Coats has been gaining market share consistently over the years while its competitors suffer from high leverage. 

According to Coats, the initial six months of 2023 witnessed a 30% reduction in global shoe production. However, this adjustment was not uniformly distributed across all categories. Coats observed that the performance and athletic products demonstrated a higher degree of resilience than the rest.   

Asics (7936 JP) is a Japan-based company in our portfolios that operates in this performance category. While the brand is also noticing weakness in North America and Europe, it is doing better than its peers and strong sales momentum in Asia helped the company to grow revenue by 15% in the latest quarter and improve margins by 150 bps, as price optimization was more than enough to offset the higher costs. Asics faces limited inventory risks compared to peers and does not offer deep discounts. It even revised up full year guidance and hiked its dividend forecast. The reasons behind the outperformance include:  

  • Focus on performance categories. Performance running shoes and core performance sports shoes (for athletics, tennis, volleyball and other competitive sports) account for around two thirds of Asics’s revenue. The total numbers of shoes to be sold by Asics this year is expected to be down 10%, as the company is trying to produce less entry-level products and focus on the premium models. Revenue is expected to be up 13.5% as a result of higher average sales prices.
  • Expand the profitable channels. Asics has been shifting its distribution channel from general sports goods retailers to specialty stores, with a very small portion of revenue coming from Foot Locker. In addition, the brand has been expanding its e-commerce and DTC channels, which have the highest margins. Currently, e-commerce accounts for 17% of group revenue and Asics aims to achieve 25% by 2025. The company is building a running ecosystem with its OneASICS membership program, which currently has a member base of 8.3 million. Data shows members tend to spend 50% more than non-member customers.
  • Asia reopening and inbound tourism in Japan. In the June quarter, Asics’s sales from Japan increased by 42% and sales from Greater China and Southeast/South Asia increased by 35% and 56%, respectively. In Japan, sales from inbound tourists have recovered to about 90% of 2019 levels. The anticipated recovery of Chinese tourists is expected to boost sales further. Out of the sales associated with inbound tourism, over 80% was Onitsuka Tiger (OT), Asics’s high end, stylish sneaker brand. This brand enjoys much higher margins than the company average, also contributing to its margin expansion.  

The company’s further growth will be fueled by additional market share gains, new market expansion and new product launches. Asics has been gaining market share from peers globally, now has 13% to 14% share in North America and Japan, 29% in Europe, and expects to continue this trend by offering competitive products. As a next leg of growth, Asics will look to expand its presence in emerging markets especially in Asia, as there is rising demand for sports goods and services in the region. Asics is also launching new products in other sports and has been gaining market share. It already claims the top market share in tennis shoes in Europe and the US.  

Sustainability is also a big focus for Asics. Over 90% of Asics’s running shoes contain recycled polyester. In 2022, the company unveiled the lightest ever CO2e emissions sneaker, emitting just 1.95 kg per pair, over 80% less than a regular pair of sports shoes on the market.  

With its competitive and eco-conscious product offerings, coupled with well-defined growth strategies, Asics is poised to sustain its expansion in the years to come.

Global Alpha Capital Management Ltd.
August 31st, 2023