1H22 results slightly miss our expectation

Hefei Department Store announced its 1H22 results: Revenue grew 2.2% YoY to Rmb3.3bn, attributable net profit fell 24.5% YoY to Rmb104mn and recurring attributable net profit dropped 47.8% YoY to Rmb52mn. The firm’s results slightly missed our expectation, which we attribute to a decline in its gross margin due to fiercer competition. Revenue increased 0.2% YoY in 1Q22 and 5.1% YoY in 2Q22, but attributable net profit fell 15.6% YoY and 55.9% YoY. Recurring net profit declined 26.0% YoY in 1Q22 and turned negative in 2Q22.

Trends to watch

1H22 revenue remained largely stable YoY. The firm’s 1H22 revenue increased slightly by 2.2% YoY, with that in 2Q22 rising 5.1% YoY. 1) Department store business (including household appliance business): Revenue fell 8.11% YoY to Rmb1.15bn, and we expect COVID-19 resurgence to have a lingering impact on offline footfall. 2) Supermarket business: Revenue rose 8.56% YoY to Rmb1.90bn as competition eased. 3) Agricultural product wholesaling business: Revenue dropped 2.88% YoY to Rmb189mn. 4) Real estate business: Revenue soared 104.15% YoY to Rmb55mn, with significant YoY growth in revenue from home sales. In 1H22, the firm closed 1 department store, 6 supermarket stores and 0 household appliance stores on a net basis. The total number of stores at end-1H22 was 244, including 24 department stores, 195 supermarkets and 25 household appliance stores.

Falling gross margin weighed on profitability; 1H22 recurring net profit margin fell 1.5ppt YoY. The firm’s 1H22 gross margin fell 2.9ppt YoY to 29.4%, with that of department store, supermarket, agricultural product wholesaling and real estate businesses dropping 2.99ppt, 1.28ppt, 3.33ppt and 23.36ppt YoY respectively. We attribute the decline to intensified competition in the industry. During 1H22, the firm’s sales expense ratio fell 0.3ppt YoY to 6.9%, G&A and R&D expense ratio dropped 0.3ppt YoY to 15.6%, and financial expense ratio fell 0.2ppt YoY to 0.9%. Overall, the firm’s attributable net profit margin fell 1.1ppt YoY to 3.2% and recurring net profit margin fell 1.5ppt YoY to 1.6%, pointing to a decline in its profitability.

Keep a close watch on the effectiveness of business transformation. 1) The firm is exploring diversified business models for its main businesses. For its department store business, the firm plans to add some innovative and cooperative business models to improve scenario-based services. For its supermarket business, the firm plans to enhance the profitability of its core products by strengthening proprietary brand power, and expanding fresh food and dine-in services to more outlets. 2) The firm continued to advance its digital transformation. Baida Shopping, the firm’s WeChat mini program, enables consumers to access various goods and services offered by the firm. Moreover, the firm plans to build a platform that integrates shopping, live streaming and membership services. We believe it will continue to pursue cross-business synergies and data sharing.

Financials and valuation

As fiercer competition has dragged the firm’s profit margin, we lower our 2022 and 2023 earnings forecasts 9% and 8% to Rmb149mn and Rmb156mn. The stock is trading at 23x 2022e and 22x 2023e P/E. We cut our TP 8% to Rmb4.7 due to earnings forecast revisions, implying 25x 2022e and 24x 2023e P/E with 8% upside.

Risks

Intensifying competition; risks associated with business transformation; tightening policies in the real estate industry.