What's new
Lianhua's share price has declined recently, due to: 1) Weak CPI and concerns of sector cost increases; 2) the fact that as a small market cap stock, its liquidity is relatively low; and, 3) the market has factored in the company's January 28 announcement that its 2013 earnings will see a significant decline.
Comments
Low CPI and cost increase will continue to be concerns in 2014. The drop in CPI put pressure on SSSG; pressure from staff costs and rental expenses are the same across different sectors. Improving gross margin is the key to covering raised expenses.
2013 results alert has been largely factored in, short term sentiment will still be affected. We expect sales to see low single digit growth, but net profit will drop 50~60% (or slightly more) due to cost increase and adjustments.
Follow the trend in 2014. We think management and operational changes should be positive to Lianhua. But the impact on earnings will still need some time. SOE reform may be a catalyst.
Trend to watch
Sales growth expected to be in the low single digits in 2014; the company will continue to close some inefficient stores.
Valuation and recommendation
We maintain our HOLD rating and current forecasts; we will make any revisions after the company publishes its annual results. The previous deep corrections reflected the market's concerns, as we pointed out in our last report. 2014's performance will be determined by the effects of cost controls and operation efficiency (expected 2Q14). We trim our target price from HK$5.26 to HK$4.8 on 0.13x 2014e P/S (16x 2014e EPS), considering peers' recent valuation moves. The price has elasticity if improvements appear.
Risks
Slower-than-expected SSSG; cost increases.