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One of the most common errors we can make as contrarian value investors is the tendency to become, well, contrary or overly pessimistic. In particular, macro-economic driven pessimism can tend to blind investors to underlying positive structural trends. We strive to maintain a semi-optimistic or “glass half full” mindset and recognize that the most obvious risks tend to be self-correcting, fully reflected in asset prices and actually an opportunity.

Headlines constantly scream about unrelenting deflation and slowing economic growth, especially in relation to all things Chinese. This negativity is overshadowing the powerful developments in the Chinese consumer sector and in particular, fitness and sports-related spending. Despite the slowdown in overall economic activity in China, growth in the number of “affluent” households has accelerated since 2008. And the number of affluent Chinese households is expected to continue to grow strongly, more than doubling over the next decade.

Researchers at Gavekal and Macquarie Research show that this dynamic shifts consumption from necessities to niceties such as travel, recreation, restaurants, luxury goods and services. Spending on athletics, sports and related gear is a major beneficiary of this income cohort’s expansion (Exhibit 1).

 

Exhibit 1: Sports-Related Spending Rises With Affluence

*Sports nutrition products used to build muscle and boost energy, such as protein bars and powders. Does not include mass market sports drinks or low-protein bars. Source: Gavekal Data/Macrobond, Euromonitor.

 

China is also starting from a very low base of participation in exercise and sports. U.S. per capita spending in this category is more than 16 times that of the average Chinese citizen. In fact, our Sino friends allocate very little to athletic activities compared to other nations. This has not gone unnoticed by government officials. As part of Premier Li Keqiang’s deregulation push, he has made it much easier to get approval for large sporting events. Consequently, the number of marathons held in China is growing at an annualized rate of 62%. President Xi Jinping, a big soccer fan, has pledged to increase the number of fields from 10,000 to 70,000 by 2020. And as the 2022 Winter Olympics in Beijing approaches, the government is explicitly targeting a near doubling of sports-related spending as a percentage of total GDP.

From an investment standpoint, the leading domestic athletics and footwear firms - Anta, Li Ning, 361 Degrees, Xtep and Peak - are all trading at significant discounts compared to large global brands such as Nike and Adidas. While the two athletic giants are enjoying strong growth in China, they appear to be already pricing in much of this long-term opportunity. Fundamentally we find both Anta and 361 best positioned for long-term growth. Both companies understand the mistakes of the past cycle and are focused on spending to build brand awareness and not just opening thousands of new locations. Clearly the competition from the established leaders will remain tough but so far these two companies continue to prosper.