2021 results in line with our forecast

Zhang Xiaoquan Inc. announced its 2021 results. Revenue increased 32.8% YoY to about Rmb760mn and net profit attributable to shareholders grew 2% YoY to Rmb79mn; recurring attributable net profit rose 3.4% YoY to Rmb74mn. The results are largely in line with our forecast, mainly thanks to the firm’s transformation into a supplier of high-quality household products and continuous expansion of new product categories.

Specifically, in 1-3Q21, revenue increased 32% YoY to Rmb515mn, and attributable net profit rose 21% YoY to Rmb63mn. In 4Q21, revenue grew 34.6% YoY to Rmb245mn, while attributable net profit declined 37.1% YoY to Rmb16mn.

Trends to watch

Rapid revenue growth driven by continuous upgrade in distribution　channels, products, and brand. In 2021, the firm’s revenue increased 32.8% YoY to around Rmb760mn. Specifically, revenue from knives and scissors, kitchenware and kitchen appliances, and household hardware products came in at Rmb526mn, Rmb149mn, and Rmb79mn, with YoY growth of 20%, 95.9%, and 47.8%. We attribute the high revenue growth to the firm’s strong distribution channels, products, and brands.

Distribution channels: Zhang Xiaoquan is establishing a solid omnichannel presence to drive coordinated growth in online and offline distribution channels. It is actively adjusting strategies for products in retail channels and expanding into live-streaming channels. Meanwhile, the company is developing products targeting overseas markets. We expect rapid growth in various channels.

Products: The firm focuses on launching new series of knives and scissors and developing promotional gifts to boost sales. It is building a new organizational and management model to drive the growth of kitchen appliances and other new product categories.

Brand: The firm’s brand exposure and interactions in online channels grew by 23x and 42x YoY in 2021 as it seeks to transform itself into a high-quality household product brand, with brand recognition and reputation continuing to improve.

Modest decline in profitability due to high raw material prices and　increasing selling expenses. In 2021, the firm’s gross margin declined 2.1ppt YoY to 38.6%, which we attribute to high prices of upstream raw　materials including steel, PVC, and packaging materials. In 2021, its overall expense ratio rose1.3ppt YoY to 25.1%, while selling expense ratio rose 0.9ppt YoY to 15.4%, mainly due to increased efforts in brand promotion and product marketing, as well as the low base effect in 2020 brought by favorable government policies amid the COVID-19 pandemic.Meanwhile, the combined G&A and R&D expense ratio rose 0.6ppt YoY to 9.9%, due to the low base effect and an increased number of administrative staff. Financial expense ratio slid 0.2ppt YoY to -0.2%, thanks to higher interest income. On the whole, the firm’s profitability slightly declined, with its net margin falling 3.1ppt YoY to 10.4%.

Stronger competitiveness in distribution channels, products, and brand; bright growth prospects amid the rise of Chinese brands.

Channels: On the one hand, we expect the company to step up its investment in store decoration, store shelves and product display in offline channels, which should help it quickly gain market share. On the other hand, we think the firm will strengthen its management over online direct selling stores on the mainstream third-party e-commerce platforms, introducing new products to cater to the users on those platforms. In addition, we think the firm will accelerate retail store openings and enhance the operating capabilities of existing stores.

Products: We believe the firm will actively expand its product lines, and improve its technology R&D capabilities and workforce.

Brand: We expect the firm to integrate its resources on different new media platforms to foster brand recognition. We are upbeat on its growth outlook amid the trend of consumption upgrading and the rise of Chinese brands, backed by improving competitiveness.

Financials and valuation

Considering the high costs of raw materials, we lower our 2022 earnings forecast 13% to Rmb105mn, and introduce a 2023 earnings forecast of Rmb131mn. The stock is trading at 27x 2022e and 22x 2023e P/E. We maintain OUTPERFORM. Based on our earnings forecast revisions, we cut our target price 13% to Rmb26, implying 38x 2022e and 31x 2023e P/E, offering 42% upside.

Risks

Sharp fluctuations in raw material prices; intensifying competition; risks related to outsourced manufacturing.