Disappointing 3QSSSG came as a surprise to us. Daphne reported disappointing 3QSSSG of -18.1% YoY and 9MSSSG of -12.2% YoY, less growth than we expected. We believe the key drivers of weak SSSG disappointment are now fundamental. We downgrade Daphne from BUY to HOLD, cutting our FY13/14E earnings by 3%/11% on weaker-than-expected SSSG. Our new target price of HKD4.91 implies 12.6x FY14 P/E. We believe a lot of negatives have been priced in after the share price correction; yet we wait for signs of improvement. More than weather impact. Daphne has indicated that weak sales in 3Q were mainly from 1) extremely hot weather in July and August in China; 2) strong competition; 3) weak consumer sentiment. We believe Daphne's weakness is more than just a weather issue. One of the company's competitors, Belle (1880 HK, NR), reported 3Q13 SSSG of 1.3% YOY, showing QoQ improvement despite department store traffic declining in July and August. At t he same time, Daphne's SSSG further declined to -18.1%. In our view, the product offering is one of the key causes of weak sales, as evidenced by discounting throughout the year.
Store over-expansion in recent years. Stores have been aggressively opened in the last three years, with over 700 stores net opening per annum. A net closure of 17 stores starting from 3Q13 has revealed a low visibility outlook as the focus of store efficiency has not yet shown that it can improve SSSG. In our view , Daphne is likely to continue to close stores due to 1) high rental pressure from stand-alone stores; 2) less focus on franchises; 3) online retailers continuing to capture sales. Possible further earnings cuts from the Street , which currently forecasts a 15% YoY increase in FY14 net profit to HKD789m, despite low visibility on SSSG, leading to great er risk for earnings cuts.
SSSG could turn from an easier base for FY14, but there is weak indication on how management could turn around the business in the near term.