Profit in 2012 was 4% below consensus , but in line with our forecast. Core profit fell 7% to RMB600m on 2.1% same store sales growth (SSSG). Operating deleveraging was more pronounced in 2H12, as core profit fell 16% on flat SSSG due to: (1) slower-than-expected growth in fee income from suppliers; (2) faster growth in staff costs due to conversion of concessionaire spaces into fre sh products sections and opening of eight large stores in 4Q12. The final dividend of RMB0.21 yields a full-year payout of 42.7%, similar to 2011.
This year will be better. We see a 13% pick-up in core profit this year, driven by: (1) early conclusion of supplier contract negotiation, leading to faster y-o-y growth in supplier income; (2) total operating expenses growing 15%, similar to 2012, but top line growing 13%, more than twice as fast as in 2012 on better SSSG of 4.5% and full-year contributions from new stores opened in 2012. With regards to costs, we note in particular that growth in staff costs will slow to 21% in 2013e from 26% in 2012 as a result of increased use of part-time workers and a high base effect created by the increase in staffing needs relating to the restructuring of the fresh products section in 2012. But we struggle to become bulls. We argued in our February report China Grocery Retailers that Wumart is fighting gravity on margins from: (1) a mature store profile; (2) the opening of more hypermarkets; and (3) allocation of more floor pace to fresh products sections. Also, there are signs that the cannibalisation of traditional retail by online shopping in the non-food segment is particular ly severe in first-tier cities, like Beijing, where Wumart generates about 85% of its sales. With limited upside to Wumart’s operating margin, we see little justification for a higher PE.
Upgrade to N . With the recent decline in the share price, our revised TP implies 5.5% potential return and we upgrade to Neutral. Du e to minor adjustments to our forecasts, our DCF-based TP rises to HKD14.5 from HKD14.2. Upside risks include: better-than-forecast SSSG (3% for the year so far). Downside risks include: more aggressive promotions driving down GPM.