1-3Q21 earnings missed our expectations

Hefei Department Store (Hefei) announced its 1-3Q21 results: Revenue fell 0.8% YoY to Rmb4.68bn, and attributable net profit grew 25.0% YoY to Rmb158mn, missing our expectations, mainly due to intensifying competition; recurring net profit grew 12.4% YoY to Rmb85mn.

Specifically, revenue rose 9.0% YoY in 1Q21 but fell 8.2% and 5.0% YoY in 2Q21 and 3Q21, net profit grew 80.3% YoY in 1Q21 but declined 15.6% and 34.7% YoY in 2Q21 and 3Q21, and recurring net profit grew 110.5% YoY in 1Q21 but fell 18.7% and 190.9% YoY in 2Q21 and 3Q21.

Trends to watch

1-3Q21 revenue slightly down 0.8% YoY. In 3Q21, revenue fell 5.0% YoY, and its YoY decline narrowed from 2Q21. Department stores: We think revenue growth have slowed slightly in 1-3Q21 vs. 1H21 due to COVID-19 resurgence and the high base formed in 3Q20. Supermarkets: We believe 1-3Q21 sales fell slightly YoY due to a high base as the government required Hefei to supply goods to some communities under lockdown last year amid the COVID-19 outbreak in China. Agricultural products: Revenue from this segment might have slightly improved.

Profitability improved. In 1-3Q21, the firm’s gross margin (GM) rose 1.8ppt YoY to 31.1%. Selling expense ratio fell 0.3ppt YoY to 7.2%, G&A expense ratio rose 0.8ppt YoY to 16.3%, and financial expense ratio grew 0.5ppt YoY to 1.2% due to higher interest expenses under new leasing principle. As a result, the firm’s net margin grew 0.7ppt YoY to 3.4%, and its recurring net margin grew 0.2ppt YoY to 1.8%, showing improved profitability.

Implementation of “dual-driver” strategy seeing steady progress; watch outcomes of transformation and innovations. In the department store business, Hefei has consolidated its advantages in competitive product categories, introduced high-end and new brands, and raised the proportion of upgraded quality products. Joymart - Hefei’s supermarket chain - continued to explore the partnership mechanism for consolidating its advantages in core product categories and strengthen its presence in the fresh food segment. In addition, Hefei’s various businesses are generating synergies to drive growth as it strives to integrate development of the agricultural product and supermarket businesses and improve sharing of resources. The firm is enhancing regional synergies to improve competitiveness of small and new stores for its department store business. Joymart accelerated standardization of its fresh food business. It has also increased its use of technologies to support its business - it continues to improve its CRM, WBS, and membership systems, which helps build intelligent business systems and smart wholesales agricultural product platforms. We see steady progress in informatization and digitalization.

Financials and valuation

Given intensifying competition, we slightly lower our 2021 and 2022 EPS forecasts 9% and 9% to Rmb0.24 and Rmb0.25. The stock is trading at 18x 2021e and 17x 2022e P/E. Maintain OUTPERFORM. Given lower earnings forecasts, we cut our TP 10% to Rmb5.4 (23x 2021e and 21x 2022e P/E), offering 28% upside.

Risks

Risks related to intensifying competition and business transformation; COVID-19 resurgence; tightening of policies for the real estate market.