2016 results miss expectations

2016 revenue was Rmb6.82bn, down 0.6% YoY; net profit attributable to shareholders was Rmb340mn, up 1.2% YoY,or Rmb0.27 per share. Overseas business grew rapidly and contributed 10.1% of total revenue. In 2016, domesticrevenue fell 6.6% while overseas revenue rose 131.8%. In 4Q16, gross margin fell 3.5ppt YoY due to the VAT reform,edging down 0.2ppt excluding that factor; expense ratio rose 2.5ppt YoY, as administrative expenses increased due tomore management personnel; asset impairment losses decreased 32.1% YoY from a high base; non-operating incomesurged 406% YoY thanks to more government subsidies; minority interest rose 97.8% YoY, as earnings of non-whollyowned subsidiaries increased. In 2016, the company recorded a net operating cash outflow of Rmb570mn (net inflow ofRmb340mn in 2015), as payment collection from some property decoration projects was relatively slow.

Trends to watch

Real estate industry stronger than expected. Public decoration business will benefit from increasedinvestment in public facilities. We expect new property starts (in GFA terms) in 2017 to increase 10% YoY andinvestment to grow 7% YoY, driven by strong property sales in tier-3/4 cities. Our recent grassroots survey also showsthat investment in public facilities is increasing, which will benefit the company’s public decoration business.

Beneficiary of Belt and Road Initiative. In 2016, new overseas orders increased >300% YoY to nearly Rmb7bn. Atend-2016, overseas orders in hand accounted for nearly 50% of total orders in hand. Overseas business is expected togrow faster on the back of the Belt and Road Initiative and contribute considerable profit.

Earnings forecast

As domestic decoration business recovery is slower than expected, we lower our 2017 earnings forecast by 15%from Rmb0.38 to Rmb0.32 per share. We expect EPS in 2018 to be Rmb0.40, implying YoY growth of 24%.

Valuation and recommendation

The stock is trading at 25.2x 2017e P/E. We maintain our BUY rating, but lower our target price by 27.61% toRmb9.70 (30x 2017e P/E) due to slower-than-expected recovery in domestic decoration business andearnings forecast revisions. Future catalysts may include large overseas orders and continued strength in the domesticproperty market.

Risks

Domestic decoration business recovery disappointing; overseas business risks.