EUR 850.00 For Business Accounts Only

Morningstar | Sun Art's New Retail Initiatives Won't Reap Benefits Until 2020; Shares Fairly Valued

We maintain our fair value estimate for Sun Art even though full-year results missed our expectations. Sales and net income were respectively 5% and 4% lower than our forecasts. Management’s business plans give us more confidence in our assumption of a recovery in top-line growth and margin expansion. 2019 will be the year of acceleration of new retail initiatives and increased investment after laying the foundation in 2018. 2020 will be the year in which Sun Art will start to reap the benefits.

Revenue in the second half was down 6% year over year, due to a loss of electronic appliances sales after Suning started running the electronic appliances section in Sun Art stores on a consignment basis since August 2018. Management noted core category fresh food sales grew while nonfood categories declined. Same-store sales excluding electronic appliances were flat on a like-for-like basis in the first half versus a decline of 1.72% for the full year. Management indicated the same-store sales decline in the fourth quarter was over 8% due to weaker consumer confidence and a loss of market share to online competitors’ Double 11 and Double 12 festivals. Management is optimistic that same-store sales will grow this year. We now assume negative 0.5% same-stores sales growth in 2019.

Gross profit margin increased to 26.9% in the second half from 23.9% in the first half, helped by a higher contribution from rental income. We expect to see higher gross profit margin going forward, attributed to the higher margin of the consignment agreement with Suning and better purchasing terms with suppliers in 2019. Remodeling of the electronic appliance areas and development of online-to-offline businesses, as well as a higher minimum wage, led to 5% lower operating income in the second half.

In collaboration with Alibaba, all stores are now digitalized by integrating membership system, inventory, logistics, and supply chain and covered by Taoxianda by the end of 2018; they are expected to generate revenue going forward. We expect market share gains against traditional offline hypermarkets in the future. Management is confident that the number of orders per store per day of the business-to-consumer business will increase from 500 at the end of 2018 to 1,000 in 2019 as entrances from Tmall and Ele.me open and the company expands its delivery radius to 5 kilometers from 3 kilometers. In addition to new retail, to cut costs, management will integrate the headquarters and supply chain of Auchan and RT Mart, and RI will assist Auchan in upgrading its IT system. This integration is not expected to lead to significant expenses. By the end of March, the integration will be complete, and cost savings should follow. Management will also try to raise the gross profit margin of Auchan by 200-300 basis points to RT Mart’s level by changing producing mix. Management wants to increase traffic to its hypermarkets by having the expert in a category manage the category in the hypermarket. For example, given Suning’s leading position in the electronic appliance space, it should have a deeper understanding of industry trends and better manage the space than Sun Art.