China’s leading consumer appliances retailer with strong O2O growth; Initiate with Buy

Download our reports from Bloomberg: BOCM〈enter〉 23 January 2015 Last Closing: HK$1.15 Upside: +22% Target Price: HK$1.40 Consumer Discretionary Sector GOME (493.HK) Initiation of coverage China’s leading consumer appliances retailer with strong O2O growth; Initiate with Buy Initiate with Buy Financial Highlights Y/E Dec FY12 FY13 FY14E FY15E FY16E Revenue (RMBm) 51,097 56,401 61,573 68,518 76,746 Revenue growth (%) -15 10 9 11 12 Net profit (RMBm) -728 892 1,351 1,526 1,788 vs Consensus (+/-%) na na 5 4 4 Net profit growth (%) na na 51 13 17 Core net profit (RMBm) -728 892 1,251 1,526 1,788 Core net profit growth (%) na na 40 22 17 Core EPS(RMB) -0.04 0.05 0.07 0.09 0.11 PER (x) na 17.1 11.9 9.8 8.4 DPS (HK$) na 0.04 0.04 0.05 0.06 Yield (%) na 3.5 3.6 4.1 4.8 Source: Company data, BOCOM Int’l estimates Solid growth story. We initiate coverage on GOME with Buy and a TP of HK$1.4. We expect GOME (the second largest home appliance retailer in China) to continue to gain market share in the growing home appliance market, and its strong brand recognition, increasing effort on sales of differentiated products and proactive e-commerce development are backed by the unique omni-channel business model. Key company strengths: 1) renowned brand, 2) extensive distribution network with 1,117 stores nationwide which facilitates logistics for e-commerce, and 3) cost advantage led by effective supply chain management. Earnings and margin outlook. We expect GOME to post core net profit growth of 40% in FY14E and 20% CAGR in FY15-16E on revenue growth (9% in FY14E and 12% CAGR in FY15-16E) on steady SSS growth, store expansion, increasing e-commerce sales and margin improvement. GOME’s core gross margin is expected to remain resilient at 18.3% in FY14E (vs. 18.4% in FY13) and expand by 0.3ppt/0.2ppt to 18.6%/18.8% in FY15/16E on continuing product mix improvement and effective supply chain management. We expect core operating margin to improve by 0.5ppt/0.3ppt/0.2ppt to 2.3%/2.6%/2.8% in FY14/15/16E from 1.8% in FY13 on stringent operating cost control. Pragmatic e-commerce development approach. Our competitive study suggests that GOME’s more prudent approach of developing its online sales is more sustainable despite that Suning began its O2O integration (2010) earlier. In our view, GOME’s transformation has put more emphasis on enhancing the customer shopping experience and improving internal supply chain management, which are essential to long-term success. While the competition in e-commerce remains fierce, the fast-growing online retail market is an opportunity for GOME to expand its e-commerce (held by 60/40 JV formed by GOME/its parent), as standardized consumer appliances with transparent price information are ideal products for online sales, in our view. Moreover, timely delivery and well-organized logistics arrangement (GOME’s strengths) are value-added services to customers. GOME successfully integrated its supply chain platform to support its O2O development. With more competitive pricing and differentiated product offering, we expect GOME’s e-commerce revenue growth to accelerate in FY15-16E. With increased business scale, better product mix and improved efficiency, we expect the loss in e-commerce to narrow to RMB400mn/RMB350mn in FY15/16E from RMB450mn in FY14E. Valuation. The stock is trading at 9.8x FY15E P/E, which represents a 17% discount to its 2-year historical average (when GOME started to adopt its omni-channel business model). Our TP of HK$1.4 is based on 12x FY15E P/E, a 10% premium to the retail sector average, which we believe is a fair benchmark to reflect its O2O story. Key risks. Intense market competition, rising cost pressure, management stability concern, and sustainability of product mix enhancement. SELLNe utralLTBUYBUYStock Our FY14-16E core net profits are above consensus as we expect operating margins to continue to improve on resilient revenue growth, improved product mix, and stringent operating cost control. What not to miss: competitive study of GOME vs Suning (page 18-22) Valuation: the stock is trading at 17% discount to its 2-year historical average P/E. With its O2O development, we believe the current valuation is undemanding. Stock data 52w High 1.5252w Low 1.03Market cap (HK$m) 19,503Issued shares (m) 16,959Avg daily vol (m) 80.11-mth change（%） 6.5YTD change（%） 0.950d MA 1.1200d MA 1.314-day RSI 55.2 Source: Company data, Bloomberg 1 Year Performance chart Source: Company data, Bloomberg Anita Chu Anita.chu@bocomgroup.com Tel: (852) 2977 9205 Phoebe Wong Phoebe Wong@bocomgroup.com Tel: (852) 2977 9391 -20%-15%-10%-5%0%5%10%1