China International Travel Service: Duty-free remains lackluster; when will its fortunes turn?

On the evening of March 27th, China International Travel Service Corporation Limited (CITS) released its 2023 annual report: achieving a revenue of 67.5 billion, a year-on-year increase of 20%, and a net profit attributable to the parent company of 6.7 billion, a year-on-year increase of 33%. As usual, since the company had previously released its performance report, the overall performance was already known. The focus is mainly on the detailed data disclosed in the annual report and the trend changes in performance. The key points are as follows:

1. Still "look but don't buy", duty-free consumption remains flat: In the fourth quarter of 2023, CITS achieved a total revenue of 16.7 billion, showing an 11% increase compared to the traditional peak season, breaking through after two consecutive quarters of stability. However, in terms of sales types, in the second half of 2023, the company's duty-free product sales revenue was 20.3 billion, a decrease of about 3.7 billion (15.4% QoQ) compared to the first half of the year. On the other hand, taxable sales only decreased by 1 billion (8.5% QoQ), indicating that duty-free sales are still relatively weak.

Comparing industry data, duty-free sales in Hainan's offshore islands in the fourth quarter only grew by 14% on a very low base from the previous year, with little improvement during the peak season. The number of shopping visits increased by 74% year-on-year, but the number of items sold decreased by 7%, indicating that the phenomenon of "just looking and not buying" still exists. In addition, the average consumption per person also decreased by 34% year-on-year, continuing the trend of "consumption downgrading".

2. Decline in gross profit due to taxable sales: In the fourth quarter, CITS achieved a gross profit of 5.4 billion, a slight increase of 0.2 billion compared to the previous quarter, significantly less than the revenue increment. The gross profit margin decreased from 34.5% to 32%, resulting in a gross profit that was nearly 9% lower than expected.

However, looking at the types, the gross profit margin of duty-free sales in 2023 was 39.5%, slightly higher by 0.1 percentage point compared to the previous year. In other words, despite the significant drop in average unit price this year, the discount rate on duty-free products by CITS may have narrowed.

The gross profit margin of taxable sales decreased from 17.4% to 15%, leading us to speculate that the overall decline in gross profit margin in the fourth quarter may be due to the increasing proportion of taxable sales.

However, the marketing expenses for this quarter decreased by nearly 0.2 billion to 2.48 billion, with a decrease in expense ratio of about 2.9 percentage points. Therefore, the gross sales difference in the fourth quarter actually increased by 0.4 billion to 2.9 billion, showing a good improvement.

According to the sales expense composition disclosed in the semi-annual report, lease expenses in the second half of 2023 increased by about one-third to 2.4 billion compared to the first half. Apart from newly opened stores, the growth in airport international passenger flow and related expenses should be the main reasons. However, CITS has recently renegotiated lease contracts with major airports such as Beijing and Shanghai to reduce lease expenses, so the expenses should not return to the high levels of 2020. This also confirms the relatively low profit margin space of airport channels3. Expenses did not significantly contract, profits slightly lackluster: Although gross sales increased by 400 million compared to the previous quarter, due to year-end bonuses and performance confirmations, operating expenses increased by approximately 180 million compared to the previous quarter. Additionally, business-related taxes also saw a slight increase of 50 million compared to the previous quarter, resulting in a net profit attributable to the parent company of approximately 1.5 billion this quarter, a slight increase of 200 million compared to the previous quarter, barely meeting market expectations. From the second quarter of 2023 to the fourth quarter, the quarterly net profit has been maintained at the scale of 1.3 to 1.5 billion, with a profit margin staying at the level of 9% to 10%, showing no improvement. It is somewhat worrying whether the company can reduce costs and improve efficiency on its own to enhance profitability before the improvement of consumer sentiment.

Dolphin Research Institute's Viewpoint:

From the current trend of performance, there is still no significant improvement in duty-free consumption (offshore). Since the second quarter of this year, the trend of high passenger flow, low sales volume, and a significant decrease in average transaction value, indicating a "browsing without buying" and "downgrading of consumption" trend, continues.

Currently, there are potential positive catalysts, including the recovery of inbound and outbound passenger flows, which could lead to the recovery of airport duty-free channel sales, bringing some considerable additional revenue expectations at least. However, due to the low profit margin of airport channels (due to revenue sharing with airports), the positive impact on profits will be relatively limited.

In terms of valuation, the company's profit this year is 6.7 billion, with the market expecting profits in 2024 to be roughly above 8 billion, representing a year-on-year growth of about 19% (optimistic sellers are close to 9 billion). With the current market capitalization of 172 billion, the PE valuation multiple is around 21x. Considering the profit growth rate for 2023-2024, although not cheap, it seems to have entered an observable range.

However, to drive a good performance in stock price, positive catalysts are also needed. In other words, when signals such as a significant increase in inbound and outbound passenger flows, the recovery of domestic (duty-free) consumption power, and favorable policies for indoor duty-free/Hainan customs clearance are implemented, there may be certain opportunities.

Detailed comments are as follows:

I. Despite passenger flow, duty-free sales remain weak

In terms of revenue, China Duty Free Group achieved a total revenue of 16.7 billion in the fourth quarter of 2023, a year-on-year increase of 10.9%, and a quarter-on-quarter increase of 11%. In the traditional seasonal peak of the fourth quarter, after two consecutive quarters of flat quarter-on-quarter revenue, the company finally made some breakthroughs this quarter.

However, looking at the sales types, in the second half of 2023, the company's duty-free product sales revenue was 20.3 billion, while taxable sales were 10.7 billion. Although duty-free sales saw a significant year-on-year increase due to a low base last yearHowever, in absolute terms, the duty-free sales in the second half of the year decreased by about 3.7 billion (15.4% QoQ), while the taxable sales only decreased by 1 billion (8.5% QoQ), indicating that the profit margin for duty-free sales is relatively weak.

Comparing the overall duty-free sales situation in Hainan, the number of shopping trips and consumption amount for duty-free shopping in Hainan's outlying islands in the fourth quarter remained basically unchanged from the third quarter, showing little improvement during the peak season for duty-free consumption. With a low base from last year, Hainan's overall duty-free sales only increased by 14%, still quite weak.

The main reasons are still the perennial issues of having foot traffic but no sales, and the "downgrading of consumption" reflected by the average customer spending. In the fourth quarter, the number of shopping trips increased by 74% year-on-year, but the actual sales volume decreased by 7%. Similarly, the average per capita consumption amount also decreased by 34% year-on-year.

II. Narrowing marketing expense ratio offset the decline in gross profit margin

In the fourth quarter, China International Travel Service Corporation Limited (CITS) achieved a gross profit of 5.4 billion, a slight increase of 200 million compared to the previous quarter. Considering that revenue increased by 1.7 billion, the gross profit margin decreased from 34.5% to 32%. The actual gross profit was nearly 9% lower than expected, which is not satisfactory.

However, looking at the sales types, it can be seen that the gross profit margin for duty-free sales in 2023 was 39.5%, which did not decline compared to last year, but instead slightly increased by 0.1 percentage point. In other words, despite the significant decrease in average customer spending this year, CITS did not offer much discount on duty-free products, and the discount rate may have actually narrowedThe main reason is that the gross profit margin of taxable goods sales has decreased from 17.4% to 15%, so we speculate that the overall gross profit margin decline in the fourth quarter may be due to the increasing proportion of taxable sales.

Although the gross profit margin in the fourth quarter has decreased, fortunately the marketing expenses for this quarter decreased by nearly 200 million to 24.8 billion on a month-on-month basis, and the expense ratio decreased by about 2.9 percentage points. Therefore, the gross sales difference in the fourth quarter actually increased by 4 billion to 29 billion, showing a good improvement.

Looking at the breakdown of sales expenses disclosed on a semi-annual basis, it can be seen that leasing expenses have increased by about one-third to 24 billion on a month-on-month basis. Compared to the negative leasing expenses from the second half of 2021 to 2022 (i.e., China Duty Free Group received net payments), the significant increase in leasing expenses this year, apart from newly opened stores, should be mainly attributed to the growth in airport international passenger flow and related expenses. However, China Duty Free Group and major airports such as Beijing and Shanghai have recently renegotiated contracts to reduce leasing fees, so the expenses should not return to the high levels of 2020.

III. Slight increase in profit, somewhat lackluster

Despite the 4 billion increase in gross sales difference on a month-on-month basis, due to year-end bonuses, performance rewards, etc., operating expenses also increased by about 180 million on a month-on-month basis. At the same time, taxes and fees also increased slightly by 0.5 billion, resulting in the company's net profit attributable to shareholders for this quarter being approximately 1.5 billion, a slight increase of 200 million on a month-on-month basis, barely meeting market expectations. In the end, China Duty Free Group achieved a total net profit attributable to shareholders of 6.7 billion yuan this year, an increase of approximately 33% year-on-yearEarnings and Profit Review of China International Travel Service Corporation Limited (CITS) by Dolphin Research:

Financial Reports Analysis:

October 27, 2023: Review of financial report "Revenue and Profit Both Weak, Is Duty-Free Sales Recovery Hopeless?" Link
August 26, 2023: Review of financial report "CITS: Just Browsing, Duty-Free Consumption Suffers" Link ?
April 28, 2023: Review of financial report "Travel Boom, Is Spring Coming for CITS?" Link
March 30, 2023: Review of financial report "CITS Survives the Water Crisis, Only a Decisive Counterattack is Missing?" Link
October 29, 2022: Review of financial report "In Turmoil, CITS 'Cooling' Comes as No Surprise" Link
April 23, 2022: Review of financial report "Revenue Deteriorates, Profit Recovers, CITS Still Crossing the Tribulation" Link

In-depth Analysis:

April 27, 2022: "Shadow of the Epidemic, Intensified Competition, CITS' Reversal Time Has Not Yet Come" Link
November 15, 2021: "Curse Reappears? CITS' Future Still Shining" Link
July 5, 2021: "China International Travel Service Corporation Limited (Part 1): Is Monopoly Just a Fool's Dream?" Link

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