The 1H24 results were inline but the underlying was slightly positive (e.g. resilient GP margin, as well as the restaurant-level OP margin). We agree that both Tai Er and Song are making loads of efforts to transform, but under such a tough industry and macro environment, we would not be able to turn positive, unless we can really see a compelling improvement in figures in the near term.
Despite the macro weakness, both Tai Er and Song are actively transforming themselves and we think they are making progress. Tai Er is adversely affected by subdued customer traffic and rising competition in the shopping malls, as well as the increasingly cost-conscious customers. However, we can still see it making progress in both sales and margins. For example: 1) Tai Er has proactively lowered its ASP, esp. in areas like Northeast China with a relatively lower income, where they are offering more affordable products made with the snakehead fish. 2) It has expanded target customers by introducing more new products like Sichuan-style and non- spicy dishes, the reception of which so far has been quite satisfactory (click rates of those SKUs are high), and it has also offered more delivery options for one-person meals. 3) It has rolled out more new business models, such as the store format dedicated to delivery services (already had 43 stores as at Aug 2024). Going forward in 2H24E, Tai Er will fine-tune its focus, to dedicate more efforts to improve its product quality, instead of driving down the ASP.
　　There are also positives in terms of profitability in 2H24E, such as: 1) resilient GP margin, which was well controlled in 1H24, thanks to lower procurement prices, and as promotions ease, further improvement is likely; 2) rightsizing of manpower per store, started in May 2024 (average number of staff per Tai Er store was cut to about 20), and 3) the rollout of new incentive schemes (the local management team, including the region manager, the store manager and the kitchen manager will be entitled to more profit sharing), which we believe could boost their motivation to do better and improve overall efficiency. Song Hotpot is also widening its target customer group by introducing more flavours of soup base and more new products as well as trying to boost the store productivity by opening new stores only in the existing regions. These measures should also be constructive, in our view.
　　Maintain HOLD but trim TP to HK$ 2.64, based on 9x FY25E P/E. We have fined-tuned the FY24E/25E/ 26E net profit by -3%/ +6%/ -3%, in order to factor in: 1) the weak SSSG, 2) slower-than-expected store expansion, but 3) a stronger-than-expected GP margin and staff cost control. The new TP is based on 9x FY25E P/E (cut from 13x, due to sector de-rating). The stock is now trading at 18x FY24E P/E and 9x FY25E P/E, still a bit demanding, given just a 9% 3-year (FY23-26E) sales CAGR.
　　1H24 result inline. Jiumaojiu has reported 6% YoY sales growth to RMB 3.1bn, inline with the pre-announced profit warning. It has also reported a 67% YoY drop in net profit to RMB 72mn in 1H24, slightly better than the “no more than 70% drop” issued in the profit warning. The GP margin was certainly a beat, at 64.2%, increased by 0.4ppt YoY, impressive as it was achieved with greater promotions and a falling ASP, but this was offset by the higher-than-expected staff costs. SSSG were soft for all the brands in 1H24, -8.5%/ -15.5%/ -34.7% for Jiumaojiu/ Tai Er/ Song Hotpot, hence the respective restaurant-level OP margin all retreated to 16.9%/ 13.8%/ 8.6% (from 19.2%/ 21.3%/ 13.7% in 1H23).
　　SSSG were still under pressure in Jul-Aug 2024, but sequential improvement in 4Q24E is still likely. Management has mentioned a similar SSS decline (vs 2Q24) in Jul-Aug 2024, given the high base last year, as well as a QoQ improvement in seat turnover, simply because of the seasonality (as summer is usually the peak season). But thanks to the low base last year, we believe it is still likely to see a narrowed decline going into 4Q24E.
　　The store opening plan in FY24E remained unchanged but franchising business is growing fast (esp. for the new brand Shanwaimian). The company is now targeting to open 80 to 110 Tai Er stores (we tend to think the low-end is the more likely target) and 25 Song hotpot stores in FY24E, unchanged vs last call in Jul 2024. Moreover, the franchise business may create another income stream onwards. There were already 8 Tai Er and 12 Shanwaimian stores in 1H24, and the company could have 10 Tai Er and 25 Shanwaimian stores by 2H24E.