What's new
　　Sun Art Retail preannounced its FY22 results: Revenue may fall 5.3% YoY (year ending March 31, 2022), and 2HFY22 revenue may miss our expectations by 1.1%, due to fierce competition in the industry and a COVID-19 resurgence. The firm expects to book a net loss of Rmb750-950mn in FY22, down 132.7-141.4% YoY, significantly below our expectation, due to a considerably higher-than-expected impairment loss and slightly lower-than-expected revenue.
　　Comments
　　Fierce industry competition and COVID-19 resurgence weigh on offline sales. The firm expects FY22 revenue to fall about 5.3% YoY, and that in 1HFY22 and 2HFY22 to drop 5.0% and 5.6% YoY. The firm expects the YoY decline in 2HFY22 to expand. We think intensifying industry competition and a COVID-19 resurgence will weigh on the firm’s sales. The firm’s same-store sales (SSS) saw a high single-digit decline from December 2021 to February 2022. We expect the firm’s offline sales to be under pressure in 1QFY23 (April-June 2022), as majority of the firm’s stores are located in Eastern China (e.g. Shanghai, Zhejiang, Jiangsu) where COVID-19 restrictions are most intense.
　　Profit under pressure due to impairment loss of stores and investment in marketing and new businesses. The firm expects its 2022 book profit to decline dramatically by 132.7-141.4% to a net loss of Rmb750-950mn. The expected net loss is partly attributable to a provision totaling about Rmb1.4bn for impairment loss of stores, a provision for litigation, and special bad debt accruals. In 2HFY22, the firm plans to increase investment in new businesses such as small- and medium-sized supermarkets and the community group buying business, as well as in marketing efforts such as customer education. In addition, the high base due to government subsidies in 2HFY21 may also weigh on the firm’s profit. The firm’s FY22 book net profit margin may fall 3.4ppt YoY to -1.0% based on the median of preannounced earnings, with that of 1HFY22 and 2HFY22 falling about 1.8ppt and 4.9ppt YoY to 0.3% and -2.1%.
　　Challenges in adhering to omni-channel development strategy amid COVID-19 resurgence; watch supply chain development and new business expansion. Offline business: We expect the firm to accelerate construction of small- and medium-sized supermarkets in FY23, steadily expand large supermarkets, and strengthen its supply chain. We believe the firm would enhance overall efficiency, and reduce costs and losses by developing a fresh food supply chain. Online business: We estimate the firm's online business accounted for about 30% of its revenue. The firm is increasing investment in its self-developed app, and we think the rising proportion of sales coming from the app will boost private domain traffic and per customer sales. The firm continues to deepen its business cooperation with Alibaba in shared inventory for Tmall Supermarket and the community group buying business. We expect this to strengthen synergies between the two sides and help expand Sun Art’s businesses.
　　Financials and valuation
　　Considering intensifying competition and the COVID-19 resurgence, we lower our FY22 net profit forecast from Rmb601mn to a net loss of Rmb900mn. We lower our FY23 net profit forecast 59% to Rmb505mn, and introduce a FY24 net profit forecast at Rmb798mn. The stock is trading at 38x and 24x FY23e and FY24e P/E. We maintain an OUTPERFORM rating. Considering the downward adjustment to our profit forecast and the company's medium- and long-term development prospects, we cut our target price 29% to HK$2.90, implying 47x and 30x FY23e and FY24e P/E with 23% upside.
　　Risks
　　COVID-19 resurgence; intensifying competition; disappointing growth in the online home delivery business; larger-than-expected investment in new businesses.