3Q21 results miss our expectations

Friendship & Apollo Commercial announced its 3Q21 results: In 1-3Q21, revenue rose 27.9% YoY to Rmb1.92bn, attributable net profit grew 26.0% YoY to Rmb209mn, and recurring attributable net profit increased 10.8% YoY to Rmb200mn, missing our expectations, mainly due to intensifying competition. By quarter, revenue rose 42.9% and 52.3% YoY in 1Q21 and 2Q21 but fell 0.1% YoY in 3Q21, attributable net profit grew 190.2% and 95.3% YoY in 1Q21 and 2Q21 but dropped 83.1% YoY in 3Q21, and recurring attributable net profit rose 203.3% and 29.5% YoY in 1Q21 and 2Q21 but fell 91.3% YoY in 3Q21.

Trends to watch

1-3Q21 revenue up 27.9% YoY; 3Q revenue under pressure. Revenue fell 0.1% YoY in 3Q21 due to a high base formed in 3Q20 as the firm increased efforts in marketing to respond to the government’s call for increased consumption after COVID-19 was contained in China. We think revenue was recovering in 1-3Q21. We think customer flow of offline stores largely recovered in 1-3Q21, and business operations at department stores, home appliance stores, and convenience stores are stabilizing. Subsidiary Opec Yishehui’s business on third-party platforms (e.g., Tmall and JD.com) continued to contribute revenue. The firm’s self- built shopping platforms, Tepin.hk and Toua Mall, create synergy with the offline business. We think the firm continued to open franchise stores to expand its presence in the convenience store business in 3Q21.

Profitability down slightly. In 1-3Q21, the firm’s gross margin (GM) rose 0.6ppt YoY to 47.7%, but GM fell 3.8ppt YoY to 42.7% in 3Q21. In 1- 3Q21, selling expense ratio fell 3.4ppt YoY to 17.2%, while combined G&A and R&D expense ratio dropped 3.9ppt YoY to 20.2%. We attribute this to the recovery of fixed cost such as rent and labor cost. Financial expense ratio grew 1.0ppt YoY to 11.8% as interest expenses rose under new leasing standard. Overall, net margin fell 0.2ppt YoY to 10.9%, and recurring net margin fell 1.6ppt YoY to 10.4%.

Watch progress of business innovation and service upgrades. The firm has actively promoted business innovation and service upgrading. 1) Offline business: The firm is introducing emerging types of business operation, and the expansion of 7-Eleven convenience store business is progressing smoothly. It is also seeing steady progress in store digitalization. The new City Outlet Xile store has added intelligent experiential services. 2) Online business: The firm established a regional strategic partnership with China Telecom in Hunan province and plans to jointly build a 5G Internet of Things (IoT) smart home shopping platform in the future. It launched the Youa Shopping Mall platform on July 17 to further integrate its online and offline businesses.

Financials and valuation

Due to fiercer competition, we trim down our 2021 and 2022 EPS forecasts 11% and 11% to Rmb0.19 and Rmb0.20. The stock is trading at 16x 2021e and 15x 2022e P/E. Maintain OUTPERFORM. Given changes in earnings forecasts, we lower TP 10% to Rmb3.72 (20x 2021e and 19x 2022e P/E), offering 22% upside.

Risks

Intensifying competition; weak consumption; COVID-19 resurgence.