Key takeaway

RED STAR MACALLINE's core logic is no longer store scale expansion during a property expansion cycle, but rather a recovery in asset efficiency after existing-home renovation demand provides a floor and industry supply is cleared out. In the short term, the company is affected by investment property revaluations and weak traditional home furnishing demand; however, rental cash flow from core stores remains resilient, and occupancy rates are stabilizing; the introduction of new formats such as appliances, automobiles, dining, and design centers helps boost foot traffic and sales per square meter, stabilizing rental cash flow from core properties. As occupancy rates, rental cash flow, and debt pressures continue to improve, the logic of its valuation repair will shift from asset discounts to operating cash flow realization.

Thesis

Industry demand is shifting from new homes to existing homes, making home furnishing and building materials consumption more routine.

The downturn in new home sales, starts, and completions has weakened traditional store foot traffic, but second-hand home decoration, old home renovation, partial remodeling and replacement, and aging-friendly modifications are becoming new sources of demand, with the above-scale market stabilizing at RMB1.5tn. We believe existing-home renovation demand has significantly surpassed new-home decoration demand, and the home furnishing industry is shifting from being "driven by concentrated new home deliveries" to being "driven by cyclical existing-home renewal."

Supply-side clearance brings recovery opportunities for leaders.

The building materials and home furnishing store industry has moved from past area expansion into a phase of supply-side clearance, where inefficient stores exit and industry area contracts, driving a recovery in sales per unit area and operating efficiency. Average sales of above-scale stores have been rising year by year, and average operating area has remained broadly stable over the past five years, proving that high-quality stores benefit from rising industry concentration, with their occupancy rates, sales per square meter, and tenant operating quality gradually recovering. RED STAR MACALLINE is also closely following the industry trend through a series of streamlining and deleveraging measures.

RED STAR MACALLINE's operations are gradually stabilizing and improving, with one-time write-downs lightening the load.

The significant adjustment to the company's investment property fair value does not affect cash flow, and interest-bearing debt is also being steadily absorbed. The company still maintains a nationwide store network, with 345 home furnishing and building materials stores/industry streets covering 181 cities in 2025. Core self-operated shopping malls still maintain relatively high gross margins, and occupancy rates have also begun to recover to over 85%, with cash flow gradually improving.

New business formats are improving store traffic and occupancy rates.

By supplementing its traditional home furnishing merchant structure with formats such as electrical appliances, new energy vehicles, dining, and design centers, the company is not essentially deviating from its core business but rather restructuring traffic entry points around existing-home renovation and home furnishing consumption. Trade-in programs, design centers, and the digital membership system also indicate that the company still possesses the capability to attract end-market consumer, providing a realistic foundation for subsequent operational recovery.

Investment recommendation: We estimate the company's revenue for 2026-2028 will be

RMB6,334mn/RMB6,367mn/RMB6,422mn, with net profit attributable to shareholders of the parent company of RMB71mn/RMB281mn/RMB522mn, corresponding to P/E multiples of 163X/41X/22X. Considering the company is still in the early stage of profit recovery, the asset revaluation approach is more applicable. We believe the company has entered a phase of heavy asset recovery and value revaluation. Initiating coverage, we assign an Overweight rating.

Risks:

1.Release of existing-home renovation demand falls short of expectations. If the recovery of existing-home demand such as second-hand home transactions, old home renovations, and partial upgrades and replacements is weaker than expected, or if residents' willingness to spend on renovation remains persistently weak, the company's store traffic, merchant sales, and leasing recovery may fall short of expectations.

2.Occupancy rate and rental level recovery falls short of expectations. The company's average rent has been on a general downward trend since 2018, with the overall average rent declining from approximately RMB3.05/sqm/day to approximately RMB1.85/sqm/day in 2025. If merchant operating pressure remains significant, the company may continue to maintain occupancy rates through rent reductions and rent-free periods, affecting the recovery of rental cash flow.

3.Effectiveness of new business format introduction falls short of expectations. The company is leveraging formats such as electrical appliances, automobiles, dining, and design centers to boost traffic and occupancy rates. However, if the merchant recruitment, operating sales per square meter, or consumer conversion of new formats falls short of expectations, it may be difficult to fully offset the downward pressure on traditional home furnishing and building material categories.

4.Risk of continued decline in the fair value of investment properties. The company's valuation is highly dependent on the value of its investment properties and long-term rental cash flow. If assumptions regarding long-term rental growth rates, occupancy rates, or discount rates deteriorate, investment properties may still face further impairment pressure, creating disruption to the income statement and net assets.

If the long-term growth assumption is revised downward, impairment pressure will increase significantly. With g1 held at 0.75%, if g2 declines from 2.0% to 1.8%/1.6%/1.4%/1.2%/1.0%, the corresponding potential impairment would be approximately RMB3.1bn/6.0bn/8.5bn/10.9bn/13.0bn.