Xiao Nan Guo (XNG) 1H13 results were 9.5% below our expectation asSSS growth arrived at -8.7%, 1.7 ppts lower than our expectation.Despite a 1.4% traffic flow improvement in 1H13, average spending fell by10.2%. Although gross margin improvement and an increase in other incomebeat our expectation, distribution cost grew significantly and harmed thebottom line. As such, net profit in 1H13 was RMB31.8 mn, down 43.3% andEPS arrived at RMB0.022, down 56.7%. XNG proposed an interim dividend ofHK$0.008, down 42.9%.
Despite weak results, XNG still targets to open 17 restaurants in 2H13, ofwhich another 5 “The Dining Room” restaurants will be opened by the end of2013. Traffic flow has kept improving QoQ, while we believe YoY fall inaverage spending in 2H13 will narrow on low base comparison. As such, SSSin 2H13 may show HoH improvement and arrive at -4.8%. With negativeSSS growth, XNG’s earnings will continue to be under pressure in 2H13.We cut XNG’s EPS in 2013 by 36.0% and we expect XNG’s EPS to fall by47.9% in 2013, to RM0.048. With an expectation on SSS recovery drivenby traffic flow improvement, XNG’s EPS is expected to rebound by69.2% and 27.6% in 2014-2015, to RMB0.082 and RMB0.104,correspondingly.
XNG’s SSS will recover after shifting the focus to mass market, where thegrowth potential remains. The Company’s earnings are expected to stronglyimprove in 2014-2015 on SSS rebound. We maintain “Buy” on XNG and TPof HK$1.65 remains unchanged, which represents 26.6x 2013 PER and15.7x 2014 PER.