1H22 results miss our expectations

Coco Healthcare Products (Coco Healthcare) announced its 1H22 results: Revenue declined 8.6% YoY to Rmb576mn and attributable net profit decreased 99.2% YoY to Rmb0.55mn. The results missed our forecast as falling birth rate dragged revenue of baby care products, and profit declined due to rising raw material prices and shipping rates. In 1H22, recurring attributable net profit came to -Rmb2.82mn (vs. Rmb65mn in 1H21). Revenue decreased 3.3% YoY to Rmb322mn in 1Q22 and 14.5% YoY to Rmb254mn in 2Q22. Attributable net profit fell 95.1% YoY to Rmb1.96mn in 1Q22 and turned to a loss of Rmb1.40mn in 2Q22.

Trends to watch

Baby care products dragged revenue; gross profit declined due to rising raw material prices and shipping rates. In 1H22, the firm’s gross margin declined 11.9ppt YoY to 12.2%, mainly due to rising raw material prices (e.g., pulp) and shipping rates. By business:

Baby care products: Revenue declined 23.4% YoY to Rmb271mn, mainly due to falling birth rate in China and the notable decline in demand for high-end baby diapers. Gross margin fell 11.0ppt YoY to 9.7%.

Adult incontinence products: Revenue rose 11.2% YoY to Rmb249mn, mainly thanks to the roll-out of differentiated products that drove growth of independent brands amid industry downturn. Meanwhile, the firm’s efforts to expand offline channels paid off. We estimate revenue from offline sales channels increased nearly 30% YoY, with a gross margin of 14.3%, down 13.9ppt YoY.

Pet sanitary products: Revenue grew 9.7% YoY to Rmb44mn, breaking even, mainly on rising raw material prices and price hikes that have yet to be passed on to clients.

Ramped up investment in brand marketing and R&D; profitability under pressure. In 1H22, the firm’s expense ratio was 12.0%, up 0.3ppt YoY. Selling expense ratio grew 2.7ppt YoY to 8.6%, mainly on increased efforts in brand marketing and offline channel expansion. G&A expense ratio grew 0.9ppt YoY to 2.7% due to adjustments in employee remuneration and rising land amortization expenses. R&D expense ratio rose 0.6ppt YoY to 4.4% as the firm ramped up R&D investment. Thanks to higher forex income and interest income, the firm’s financial expense ratio dropped 3.9ppt YoY to -3.7%. Attributable net profit reached Rmb0.55mn in 1H22.

Strengthening R&D and innovation, brand cultivation, and channel presence; organic development and external expansion to boost growth. The firm centers on a business model combining independent brands and original design manufacturer (ODM) and is shifting its focus to adult incontinence products. For the ODM business, it plans to explore new clients to ensure stable growth. For independent brands, we think the firm will enhance its R&D capabilities to cope with falling downstream demand. It has also stepped up efforts in brand cultivation and continues to expand into special channels. We believe these efforts should help the firm continue to lead consumer education in the incontinence products market, fueling mid- to long-term growth.

Financials and valuation

As downstream consumption was under short-term pressure due to COVID-19 resurgence and as raw material prices stay high, we lower our 2022 and 2023 net profit forecasts 52% and 30% to Rmb64mn and Rmb154mn. The stock is trading at 50x 2022e and 21x 2023e P/E. Maintain OUTPERFORM. We roll valuation over to 2023e and cut our TP 21% to Rmb14.00 based on lower earnings forecast and considering that the growth trend of the company’s proprietary-branded incontinence products for adults is positive and the company might consolidate its leading position through its advantages in product, R&D, channels, etc. Our TP implies 25x 2023e P/E with 20% upside.

Risks

Volatile raw material cost; intensifying market competition; policy execution disappoints.