1~3Q13 results slightly missed expectations

1~3Q13 operating revenue was Rmb38.976bn, up 5.8% YoY; net profit dropped 8.71% YoY to Rmb910mn (down 9.74%YoYexcluding non-recurring gains/losses) or Rmb0.53/sh, slightly missing the market and our expectations. The department store segment (department stores + shopping malls + outlets) grew steadily, but Lianhua Supermarket suffered a loss of Rmb5mn in 3Q13, dragging down earnings.

Retailer revenue growth widely slowed in 3Q13. The company’s 3Q13 revenue growth slowed from 6.76% YoY in 1H13 to 3.62% YoY, mainly due to the weak recovery of consumption (China’s top 50 retailers posted average retail sales growth of9.2%, 9.9% and 7.8% in July, August and September) and retreating gold and jewelry sales that drove up revenue in 1H13.

Narrowed gross margin and effective SG&A expense control. 1~3Q13 gross margin fell 0.45ppt YoY to 21.67%, partly due to more promotional efforts implemented in the low season. In the context of rising wages and rental costs in the sector, the company’s SG&A expense ratio narrowed 0.01ppt YoY to 17.84%in 1~3Q13, showing the economies of scale resulting fromits restructuring.

Lianhua Supermarket was at a loss and the department store segment grew slowly. Lianhua Supermarket suffered a loss ofRmb5mn in 3Q13 compared to the Rmb28mn profit it earned in 3Q12. Excluding such impact (Shanghai Friendship holds a 55.2% stake in Lianhua), we estimate the department store segment’s net profit to have grown in the low single-digits, partly due to two new stores opened in 1H13.

Prime commercial properties with high asset values. Most of the company’s commercial properties are located in Shanghai’s core business districts. It currently has 1.3mn sqm of attributable commercial property and 0.15mn sqm of logistics bases.

Trends to watch

Store openings: The company has been slow to develop its Yangpu Binjiang store and Shiboyuan Square. Its acquisition of a 30% interest in Hangzhou Outlets and a 51% stake inWuhan Outlets is underway, and the Nanjing Outlets project scheme has been finalized. The company is likely to benefit from the free trade zone and SOE reforms.

Earnings forecasts revision

Considering Lianhua Supermarket is unlikely to drive up its earnings in the short term, we lower our EPS forecasts by7.7% to Rmb0.65 for 2013 and by 9.1% to Rmb0.70 for 2014, implying earnings growth of -4.8% and 9.0%.

Valuation and recommendation

Maintain BUY.The stock is trading at 15.1x 2013e P/E, at the mid-tier of the sector. Investors should watch sales trends, whether Lianhua could stabilize on the low base, equity acquisition in outlets, SOE reforms, and Shanghai Disneyland progress.Risks:Sluggish consumption; Lianhua Supermarket persistently at a loss.