1H22 results miss our expectations

Shuhua Sports announced its 1H22 results: Revenue fell 14.9% YoY to Rmb620mn, net profit attributable dropped 19.0% YoY to Rmb47mn, and recurring net profit attributable declined 29.1% YoY to Rmb35mn. The firm’s results missed our forecast, as the impact from COVID-19 was greater than we expected in 1H22.

In 1Q22, revenue fell 13.7% YoY to Rmb278mn, and net profit attributable rose 4.3% YoY to Rmb13mn; in 2Q22, revenue fell 15.7% YoY to Rmb342mn, and net profit attributable dropped 25.6% YoY to Rmb34mn.

Trends to watch

COVID-19 weighed on revenue. The firm’s revenue fell 14.9% YoY in 1H22, which we attribute to the impact of the COVID-19 resurgence in some regions in China. The firm sells most of its indoor fitness equipment and all outdoor fitness equipment via offline distribution channels, and its display shelf products are also sold to brick-and-mortar stores. As a result, the COVID-19 resurgence in 1H22 seriously impacted downstream demand for the firm’s products, and also weakened production and logistics, weighing on the firm’s revenue in 1H22.

Gross margin (GM) improved. In 1H22, GM increased 0.6ppt YoY to 29.2%. The GM rose 3.0ppt YoY to 29.0% in 1Q22 and fell 1.3ppt YoY to 29.3% in 2Q22. Expense ratio increased 2.3ppt YoY to 20.0% in 1H22, with selling, administrative, financial, and R&D expense ratios moving +0.37ppt, +1.46ppt, -0.10ppt, and +0.51ppt YoY to 8.87%, 8.37%, 0.03% and 2.69%. The firm increased R&D spending. Despite a sharp increase in expense ratios, Shuhua’s attributable net margin only edged down 0.4ppt YoY to 7.56% in 1H22, thanks to a higher GM and higher government subsidies.

Upbeat on long-term growth potential of sports and fitness industry amid policy tailwinds; watch progress of channel upgrading and COVID-19 impact in China in short term. Long term: Global Wellness Institution (GWI) estimates the market size of the global fitness industry is likely to reach US$1.20trn at a CAGR of 10.2% over 2020–2025. China’s participation rate in sports and exercise and per-capita spending on fitness still lag far behind developed countries. In recent years, the government has released a series of documents such as the National Fitness Plan (2021–2025). We believe these policies will continue to boost the expansion of China’s sports industry. As a leading domestic fitness equipment brand, Shuhua may benefit from the robust momentum of the sports industry on the back of its competitive advantages in brands and channels, in our view. Short term: Shuhua has continued to promote the upgrading of brick-and-mortar stores. It is transforming stores that previously only served as sales channels toward a sports experience space integrating sales, experience, and guidance. We think the channel upgrading may improve the firm’s store efficiency. In addition, we suggest paying attention to COVID-19’s impact on consumer demand in China.

Financials and valuation

Given a greater-than-expected impact from COVID-19 in China, we lower our 2022 and 2023 revenue forecasts 23.7% and 22.4% to Rmb1.47bn and Rmb1.76bn, and cut our 2022 and 2023 EPS forecasts 24.1% and 21.7% to Rmb0.30 and Rmb0.36. The stock is trading at 32x 2022e and 26x 2023e P/E. Maintain OUTPERFORM. Considering the earnings forecast revisions, we cut our target price 20% to Rmb12.40 (42x 2022e and 34x 2023e P/E), offering 32% upside.

Risks

COVID-19 resurgence weighs on demand; sharp increase in raw material prices.