We are still highly cautious on the catering sector (as well as Nayuki) because of price war induced by the weakening macro demand and surge in competitions. We maintain BUY on Nayuki only because of its: 1) high cash level (over 75%+ of its market cap), 2) potential income and profits from ramp up of its franchising business and 3) efforts to reduce/ control store level and headquarter costs.
　　SSS trend YTD has been negative and we see limited catalysts ahead. Nayuki’s SSSG for Jan/ Feb/ Mar 2024 were at -29%/ -34%/ -30% (driven by drop in both ASP and volume), even worse than 7% drop in 2H23. We believe this depressing trend was due to high base and increase in competition.
　　Store expansion plan in FY24E is conservative even with boost from franchising. Back in FY23, about 417 stores were opened, that was inline with the guidance. For self-operated business, management is now guiding for ~200 new stores (10+ in overseas), however, ~150 stores could also be closed. Hence, the net increase would be rather handful. For franchising business, around 80 stores were opened in FY23 and there were roughly 200 stores by 1Q24. Management is aiming for only 200 to 400 franchised stores in FY24E. But the 2-3 years target of 2,000-3,000 new stores is still valid.
　　FY24E outlook is quite mixed, as we see pressure for topline but some room for margin improvement. For topline growth in FY24E, we are now forecasting 14% growth, which is driven by: 1) 3% increase in store counts (excluding franchise), 2) 6% increase in sales per stores (ramp up of new stores opened last year while the average ASP and daily orders will still be down by both 5% YoY), 3) ramp up of sales from RTD and franchising business (sales of raw materials to its franchise). For net profit margin in FY24E, we do expect it to improve to around 1.1%, which is a mixture of: 1) stable GP margin, 2) operating deleverage from drop in ASP and daily orders, 3) potential closures of those underperforming stores (operating losses may be reduced but one-off impairment losses could also be recorded), 4) more cautious investment in the RTD business (management is aiming to narrow the losses), 5) introduction of a more asset light store format (capex per store cut from RMB 1mn to RMB 580K and store size will also be cut from 90 sq.m. to 40sq.m., 6) small profits from the franchising business (as the incremental costs are very limited), 7) limited increases in headquarter costs, etc.
　　Maintain BUY but cut TP to HK$ 3.43. We cut FY24E/ 25E net profit by 87%/ 72% to factor in: 1) slowdown in self-operated store expansion, 2) fall in sales per store and the associated operating deleverage but a 3) potential income and profit from the franchising business. We are certainly disappointed about its profitability (only expect 1.1% NP margin in FY24E) but still think the Company could survive in long run, as store level cash flow is still positive and the group is still very cash rich (accounted for 75%+ of its market cap). Hence, we have lowered our TP and changed valuation method from 20x FY24E P/E to 1.0x FY24E P/S (where a ~20% discounts to peers’ average of 1.2x was applied). It is now trading at 0.7x FY24E P/S and 20x FY25E P/E.
　　FY23 results were disappointing but should be well expected. Nayuki’s sales increased by 20% YoY to RMB 5.2bn, while net profit turned positive to RMB 13mn, with a NP margin of 0.3% (vs -10.9% last year). In FY23, average price per order dropped by 14% YoY to RMB 29.6, while average orders per teahouse per day was quite stable at 344, fell by only 1% YoY. However, the trend deteriorated in 2H23, as sales growth slowed down to just 14% and NP margin turned negative to -2.1%, driven by sharp drop in ASP and volume and the subsequent operating deleverage.