1H14 results lower than expected
Lianhua's 1H14 turnover decreased by 3.7% to Rmb15.0bn (in line), net profit was down 48.9% to Rmb98mn. The decline in the bottom line was much due to a high net profit base (Rmb191mn in 1H13 versus a loss of Rmb138 in 2H13), an effective tax rate hike and weak sales. The company almost broke even in 2Q14.
SSSG decreased by 5.37% (Hypermarket: -7.03%, supermarket: -5.04%, CVs: +17.1% due to store upgrades, mix adjustment and more value-added services). Prepaid card sales were down 24%.
Gross profit margin increased by 0.26ppt to 14.44%, thus gross profit only decreased by 1.9%. However, other income decreased by 11.5%. Selling and administrative expenses together increased by 0.8%, which dragged down operating profit by 26.6%.
The effective tax rate increased from 35.5% to 42.6%, due much to the requirement of individual outlets to pay taxes separately. Thus tax expenses were Rmb112mn in 1H14, higher than its net profit.
Trends to watch
SSSG in July was still negative, August slightly improved (the Zhejiang subsidiary turned positive). It will continue to implement reforms in terms of business adjustment, procurement and its incentive plan, but it would still need time. Good trend for fresh foods: the sales percentage was up 9ppt to 28% in 1H14, gross margin increased to 12.5%, from 10.3%.
SOE reforms are on the way but still no details yet.
Earnings revisions
We revise down our 2014/15e earnings forecast by 17% and wait for the transformation.
Valuation and recommendation
Maintain HOLD. Market expectation was low, short-term operations still under pressure but see some changes ahead. Slightly cut TP to HK$4.83 (0.14x 2014E P/S, previous: HK$4.90).
Risks
Consumption slows further.