2021 results in line with our forecast

Lily & Beauty Cosmetics announced 2021 results: Revenue fell 9.7% YoY to Rmb4.16bn and net profit attributable to shareholders grew 21.0% YoY to Rmb411mn, in line with our forecast. Recurring attributable net profit rose 17.3% YoY to Rmb363mn. Non-recurring gains and losses included government subsidies and changed fair value of financial assets. Specifically, revenue increased 15.5% YoY in 1Q21, but declined 4.4%, 2.2%, and 22.6% YoY in 2-4Q21. Recurring attributable net profit increased 18.1%, 35.5%, 4.7%, and 9.7% YoY in 1-4Q21. We attribute the decline in revenue to the changes in the cooperation model of some brands from distributorship to agency operations.

Trends to watch

Revenue declined due to changed cooperation model of brands; proportion of revenue from non-Tmall platforms increased. By business, in 2021, revenue from Lily & Beauty’s retail e-commerce business dropped 11.25% YoY to Rmb3.87bn, as brands including Pond’s and Vaseline shifted from a retail e-commerce model to a service-fee-based model. Revenue from brand marketing operations rose 8.9% YoY to Rmb217mn in 2021. By platform, revenue from the Tmall domestic platform fell 14.8% YoY to Rmb3.71bn, while that from Tmall Global rose 1.43% YoY to Rmb164mn in 2021. Revenue from other platforms (e.g., Douyin, Pinduoduo, Lazada, and Shopee) increased 272.7% YoY to Rmb281mn in 2021. The proportion of revenue from non-Tmall platforms increased slightly.

Profit margin rose due to cost control and structural adjustment of revenue. In 2021, Lily & Beauty’s gross margin (GM) rose 6.1ppt YoY to 36.5%, mainly due to cost optimization of the retail e-commerce business and a GM structural adjustment caused by the shift to a service-fee-based model. GM from the retail e-commerce business rose 6.0ppt YoY to 34.4%, and GM of the brand marketing operation service grew 2.8ppt YoY to 82.4%. On the expense side, the expense ratio grew 4.2ppt YoY to 23.1% in 2021, driven by the shift to a service-fee-based model and higher expenses. The sales expense ratio rose 3.5ppt YoY to 20.1%. The management and R&D expense ratio rose 0.8ppt YoY to 3.2%, mainly due to expenses on equity incentives and depreciation expenses of right-of-use assets. Net margin rose 2.5ppt YoY to 9.9%, and recurring net margin increased 2.0ppt YoY to 8.7%.

Watch firm’s expansion on emerging platforms and development of brands. In 2021, Lily & Beauty expanded its presence in new channels such as Douyin, on which the number of its stores rose 26 YoY to 33 at end-2021. Lily & Beauty’s subsidiary Shanghai Zhuangya was named the leading service provider of the year on Douyin. We are upbeat on the firm’s growth potential in new platforms. In addition, the firm expanded its businesses through developing new brands and investing in other brands. It not only grew self-owned brands such as momoup, Meiyitang and Yurongchu, but also invested in emerging brands including Kookie 8th and Exacting. We expect the firm to support the development of new brands by leveraging its own operating capabilities.

Financials and valuation

Considering impact of the changing brand cooperation model and expenses related to equity incentives, we lower our 2022 EPS forecast 5% to Rmb1.12, and lower 2023 EPS forecast 7% to Rmb1.23. The stock is trading at 19x 2022e P/E. We maintain OUTPERFORM. Based on our revised earnings forecast and changes in demand in the market, we cut our target price 16% to Rmb27, implying 24x 2022e P/E, offering 29% upside.

Risks

Brand churn; reliance on a single e-commerce distribution channel; fiercer competition; inventory impairment; COVID-19 resurgence.