1Q22 results miss our expectation

Zhang Xiaoquan Inc. announced 1Q22 results: Revenue rose 28.09% YoY to Rmb209mn, attributable net profit dropped 45.96% YoY to Rmb12mn, and recurring net profit declined 47.24% YoY to Rmb12mn, missing our expectations due to COVID-19 resurgence, ramp-up of new capacity, and higher investment in marketing.

Trends to watch

We expect the firm to see growth in new distribution channels and new business segments such as kitchen appliances and household hardware products; revenue up 28.1% YoY in 1Q22. The firm’s revenue grew 28% YoY in 1Q22. The revenue growth remained rapid but missed the firm’s expectation due to regional COVID-19 resurgence in China, pressure on logistics and transportation in many parts of China, and the impact of COVID-19 in Shanghai on the firm’s distribution channels. We expect the firm to continue to optimize its channels, build a new media matrix, and cooperate with new media platforms such as Douyin in an efficient manner to bolster future growth. In addition, the firm is penetrating into new markets such as kitchenware and kitchen appliances and household hardware products while developing the traditional knives and scissors business. It continues to roll out new products and sell them via distributors. We expect its revenue from new products to grow rapidly.

Yangjian capacity expanding; marketing expenses up, earnings fell. The firm’s GM in 1Q22 fell 2.6ppt YoY to 36.2%, due to high raw material prices. Its selling, G&A and R&D, and financial expenses grew 4.4ppt, 2.8ppt, and 0.2ppt YoY to 16.4%, 11.1%, and 0% in 1Q22. It increased marketing spending on e-commerce platforms such as Douyin amid COVID-19 resurgence, and the selling expense ratio increased. The firm is expanding capacity in its base in Yangjiang. We think its expenses on employee management may have grown in 1Q22, pushing up the G&A expense ratio. The net profit margin dropped 8.2ppt YoY to 6% in 1Q22.

Keep an eye on profit recovery after COVID-19 is brought under control; upbeat on long-term growth upside of the long-established brand backed by new growth momentum. In the short term, we think the firm’s revenue will likely resume rapid growth, and expense ratio will likely be diluted as COVID-19 is brought under control, logistics recover, and offline retail recovers. As a result, we expect the firm’s profit to recover. In our opinion, the firm has strong competitiveness in terms of brand, R&D, and channels. As it improves the efficiency of online and offline channels, enriches product portfolio, and enhances brand awareness, it will likely gain new growth momentum in the medium-to-long term.

Financials and valuation

Given the impact of COVID-19 resurgence, we cut our earnings forecasts for 2022 by 10% to Rmb94mn and for 2023 by 7% to Rmb121mn. The stock is trading at 27x 2022e and 21x 2023e P/E. We maintain OUTPERFORM and reduce our TP 17% to Rmb21.60 based on lower earnings forecasts. Our TP implies 35x 2022e and 27x 2023e P/E with 30% upside.

Risks

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