Revenue and profit are both weak, is there no hope for a tax-free sales recovery?

On the evening of October 26th, China Duty Free Group officially released its Q3 2023 earnings report. Since key data such as revenue and profit had already been announced in the previous guidance, the market had already digested the performance, so it would not have much impact on the company's stock price. Let's purely look at the performance trend of China Duty Free in the third quarter:

1. Slow recovery in duty-free shopping due to focus on entertainment rather than shopping: In the third quarter, China Duty Free achieved total revenue of nearly 15 billion yuan, with a year-on-year growth rate slowing down to 28%. Despite the significant recovery in travel and tourism consumption during the summer period, the recovery of duty-free shopping was noticeably slow.

In terms of financial data, Q3 revenue slightly declined compared to Q2. According to customs data, the daily sales amount of duty-free products in Hainan during the National Day holiday was 166 million yuan, lower than the 177 million yuan during the May Day holiday. The average consumption per person was also only 7,824 yuan, which was lower than the average consumption of over 8,000 yuan during previous holidays. As a result, although the number of tourists to Hainan has increased significantly, the growth of duty-free shopping amount has been slow.

Dolphin Research believes that, on the one hand, there seems to be a crowding-out effect between domestic residents' consumption on tourism services and goods. On the other hand, the company's measures to crack down on daigou (overseas personal shoppers) and reduce member points (which can be used to offset payments) help maintain the market environment and the company's profit margin, but are not conducive to revenue growth.

2. Improvement in gross profit margin, increased marketing expenses, and decline in profit: Due to the measures taken against daigou and the difference in the proportion of duty-free/taxable sales revenue, China Duty Free's gross profit margin has continued to improve for several consecutive quarters and has reached 34.5% in the third quarter. However, due to the lack of revenue growth, the gross profit only slightly increased from 4.95 billion to 5.16 billion.

On the other hand, the likely recovery of international passenger traffic at airports has led to a corresponding increase in airport leasing expenses. The company's marketing expenses in this quarter reached 2.7 billion yuan. In a situation where revenue and gross profit remained stagnant, marketing expenses increased by about 500 million yuan compared to the previous quarter, seriously dragging down profits. It is highly likely that the drag on profitability will continue as airport passenger traffic further recovers.

3. Other expenses have slightly decreased, but unable to rescue the decline in profits: Although the company's administrative expenses, financial expenses, and tax expenditures have decreased slightly on a MoM basis, their absolute contribution is small, resulting in a decrease of approximately 200 million yuan in operating profit this quarter. In addition, taxable fees have increased, leading to a decrease in net profit of nearly 300 million yuan. Therefore, not only is the revenue growth weak, but the profit is also declining (last year's base was too low, making the MoM comparison more meaningful).

Longbridge's Dolphin Research viewpoint:

Overall, the revenue growth of China Duty Free in this quarter is weak, and the actual MoM decrease is slight. The already low net profit has also decreased by nearly 300 million yuan on a MoM basis. Key indicators such as total sales amount, per capita consumption, and tourist shopping conversion rate in the duty-free industry continue to deteriorate. Optional consumer goods consumption is currently the weakest segment among various types of consumption. Looking at the medium and long-term trends, the competition in the duty-free retail channel is becoming increasingly fierce, which is a certain trend (whether it is Hainan Island or airport channels). Moreover, there is currently no clear positive logic for indoor duty-free and the policy direction after the closure of Hainan. In the short or long term, the company lacks a clear positive outlook.

In terms of valuation, the market's current expectation for the company's full-year profit is approximately 6.5 billion yuan, corresponding to the company's current market value of slightly less than 190 billion yuan, with a PE ratio of nearly 30x, indicating that the company's valuation is still not cheap, even on the high side. Unless duty-free consumption significantly rebounds in 2024, there is still considerable room for compression in terms of valuation and performance matching.

Dolphin Research's previous studies on China Duty Free:

April 28, 2023, "Travel Boom, Is China Duty Free's Spring Coming Soon?"

March 30, 2023, "China Duty Free Survived the Water Crisis, Only One Step Away from Counterattack?"

August 31, 2022, "Entering a Truce Period Amid the Pandemic, China Duty Free Finally Stabilizes"

April 27, 2022, "Under the Shadow of the Pandemic and Intensified Competition, China Duty Free's Reversal Has Yet to Come" April 23, 2022: "Revenue Deterioration, Profit Recovery, and China Duty Free's Struggle" (source: Longbridge)

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