Under the epidemic, China Duty Free Group finally stabilized during the ceasefire period.

On the evening of August 30th, China Duty Free Group released its 2022 interim report. As the company had previously released a quick report, there was no unexpected performance for this period. Therefore, the focus can be on the trend changes in the company's operations and the incremental information disclosed in the semi-annual report, as follows:

1. Second-quarter revenue declined significantly but outperformed the industry: In the second quarter, China Duty Free Group achieved revenue of RMB 10.9 billion, a year-on-year decrease of 37.5%. Although the absolute performance was ugly under the impact of the epidemic, compared with the overall 51% decline in tax-free sales on Hainan Island this season, China Duty Free Group's revenue performance was better than the industry, and its market share stabilized and rebounded.

In terms of business, the company achieved tax-free product sales of RMB 16.2 billion in the first half of the year, a year-on-year decrease of 34%. In contrast, taxable sales achieved revenue of RMB 11.2 billion, a year-on-year growth of 5.6%. Due to the fact that taxable sales include some online channels, the company successfully offset losses in offline consumption caused by the impact of the epidemic through the online channel department. However, taxable product profits are lower than tax-free, so the increase in the proportion of taxable products will drag down the company's overall profits.

2. Gross margin stabilized, competition entered a ceasefire period: Corresponding to the better revenue growth than the industry, the company's gross margin in the second quarter also stabilized at 34%, and did not continue to deteriorate. Dolphin Analyst believes that under the situation of huge reductions in passenger traffic and revenue, the willingness of various duty-free retailers to compete for customers through price wars will also decrease (the total passenger traffic is limited, and no amount of discounts can attract a large number of customers). Therefore, the price war has temporarily entered a ceasefire period under the epidemic, and competition has eased somewhat.

The confirmed marketing expenses in the second quarter were only RMB 400 million, a significant decrease. The main reason was the renegotiation of the lease contract with Baiyun Airport, which returned approximately RMB 700 million in rent, which also reflects the company's enhanced bargaining power. Therefore, after deducting costs and marketing expenses, the company's gross sales margin increased by nearly 5 percentage points to 30% from the previous quarter. The company's competitive landscape improved marginally in the second quarter.

However, after excluding the impact of rental expenses, the other confirmed marketing expenses for the first half of the year still increased by 17.7% year-on-year. Therefore, although competition improved marginally during the epidemic, the overall trend is still deteriorating.

3. Expense expenditures are rigid and drag down profit margins: Although the gross sales margin significantly improved this quarter, the control of the company's other expenses performed poorly. After a significant decrease in revenue, second-quarter management expenses remained at RMB 430 million, with nearly no decrease compared to the same period last year.

In addition, China Duty Free Group purchased a large amount of goods from overseas brands, and the appreciation of the US dollar against the renminbi this season resulted in the company recognizing exchange losses of RMB 470 million for the first half of the year, leading to a significant increase in financial expenses to RMB 620 million in the second quarter.

As a result, the company's net profit margin attributable to the parent company fell from 15.3% in the previous quarter to 12.7% on a quarter-on-quarter basis. The net profit attributable to the parent company was RMB 1.4 billion, a year-on-year/half-year-on-half-year decrease of 45%/46%.

Dolphin Analyst's Viewpoint:

Overall, under the impact of the epidemic, the competition in the duty-free industry seems to have eased, so as a leading player, China International Travel Service (CITS) is relatively resilient in terms of revenue and gross profit margin performance. However, compared with many Internet companies, the company's results in cost control are still significantly lagging behind, resulting in a greater deterioration in profits than revenue.

However, the company's performance in the second quarter has already been announced and digested by the market. The Dolphin Analyst believes that the company's current valuation has also adjusted to a reasonable range. Therefore, in the short term, the core factors driving the company's stock price are still the epidemic and passenger flow recovery in Hainan. According to the company's disclosure, the company's revenue in June has increased by 13% compared to the same period last year, and according to research, Hainan's duty-free sales started to recover in August. If the impact of the epidemic completely fades out, then there is a high possibility for the company's stock price to recover.

In the medium and long term, although competition has temporarily eased under the epidemic, competition is still a certain trend with the relaxation of the core barriers such as licenses. The Dolphin Analyst believes that whether it can produce obvious competitive advantages in product categories or operational efficiency will be the key to whether CITS can ultimately win.

Dolphin Research focuses on interpreting global core assets and capturing deep-value investment opportunities for users across markets. Interested users can add the WeChat account "dolphinR123" to join the Dolphin Research community and explore global asset investment perspectives together!

The following is a detailed review of the financial report:

1. Revenue plummets but still outperforms the industry

In the context of long-term quarantine in core cities such as Beijing, Shanghai, Guangzhou and Shenzhen, duty-free consumption has also been severely hit. In the second quarter, CITS's total revenue dropped sharply by 37.5% year-on-year to RMB10.9 billion. The total revenue for the first half of 2022 was RMB27.65 billion, a year-on-year decrease of 22%, and the decrease even exceeded the 21% in the first half of 2020. It can be seen that unlike the rapid rebound of travel consumption after the epidemic in 2020, although the intensity of this epidemic is lower, the duration is longer and the long-term suppression of consumption is more severe.

In terms of business types, the company achieved duty-free sales of RMB16.2 billion in the first half of the year, a year-on-year decrease of 34%. In contrast, the sales of taxable goods achieved a revenue of RMB11.2 billion in the first half of the year, a year-on-year increase of 5.6% against the trend. As taxable sales also include online channels such as Hainan Island International Duty Free and CDF Member Purchase, it can be seen that under the impact of the epidemic affecting offline consumption, the company has still successfully replaced it online, partially offsetting the loss of offline consumption. However, although the company has not disclosed the gross margin situation of the first half of the year by business, historical data shows that the gross profit of taxable goods is significantly lower than that of duty-free goods. An increased proportion of taxable business will still drag down the company's overall profits.

Although from the absolute revenue growth rate, Zhongmei's performance is certainly miserable, what is more important is Zhongmei's relative performance with the entire duty-free industry, as well as the changes in market share and competition pattern reflected.

According to customs disclosure, in the second quarter of 22, Hainan offshore duty-free retail sales fell by 51% to 6.4 billion yuan, a year-on-year decrease of 21% in the first half of the year. It can be seen that Zhongmei's revenue performance in the second quarter is significantly better than the industry, and its market share has stabilized and rebounded.

From the perspective of price-volume driving, the number of shopping people in Hainan's offshore island in the second quarter decreased by 60% year-on-year. However, fortunately, the per capita consumption amount in the second quarter increased by 23% year-on-year to 7,955 yuan, and the wallet share increased to compensate for the shrinking quantity.

Looking at it in more detail, the increase in wallet share in the second quarter was mainly due to the fact that the average number of shopping items per capita increased from 9 items in the same period last year to 13 items, but the average unit price actually fell by 8.6% year-on-year to 640 yuan per item. It can be seen that during the epidemic, consumers bought more goods at lower prices. The progress of the penetration of domestic duty-free goods into high-unit-price luxury goods is not obvious.

Second, the gross profit margin of China Duty Free Group (CDFG) also stabilized at 34%, without further deterioration. Combining the performance of this season's revenue being stronger than the industry, Dolphin Analyst believes that under the background that potential consumers are trapped at home and passenger flow has decreased significantly, the willingness of various duty-free retailers to compete for customers by increasing discounts and launching price wars has also decreased (because the total passenger flow is limited, no matter how high the discount is, it cannot attract a large number of passenger flow). This is also consistent with the situation where the Internet companies covered by Dolphin Analyst have uniformly suspended competition in this quarter and focused on profitability.

In addition, because retailers have the discretion to reflect promotional expenses as income deductions or marketing expenses, gross sales difference (the profit left after deducting cost of goods sold and selling expenses from gross profit margin) is a more reflective indicator of a company's bargaining power and market competition position.

In the case where the gross profit margin remained unchanged in the second quarter, the company's marketing expenses also decreased significantly to only 430 million yuan this season, and the proportion of revenue decreased significantly from 8.7% to 3.9% from month-on-month. Therefore, the company achieved a gross sales difference of 3.26 billion yuan this season, a year-on-year decrease of 34.8%. After deducting the cost of goods sold and marketing expenses, the remaining profit margin is 30%, which has increased significantly compared with the same period last year and the month-on-month increase. Although, as previously announced by the company, the main reason for the significant decrease in marketing expenses this quarter is the return of airport store rental expenses (estimated to be approximately RMB 700 million) following the signing of a new lease agreement with Guangzhou Baiyun Airport. However, according to the detailed composition of marketing expenses disclosed in the company's semi-annual report, rental expenses recognized in the first half of 2022 brought in revenue of RMB 380 million. Beginning in the second half of 2021, CDF was continuing to "collect" rent from the airport. This essentially reflects the bargaining power of the airport and CDF in the airport duty-free channel, which has declined with the decrease in passenger traffic, and the corresponding increase in CDF's standing in the industry (although for the same reason, once passenger traffic resumes, it is likely that the airport will regain the power to set rental prices).

That being said, excluding the impact of rental changes, other marketing expenses still increased by 17.7% to RMB 2.27 billion in the first half of the year compared to the same period last year, which reflects the intensifying overall competition faced by CDF in the offshore duty-free market outside of airport channels (although the second quarter of lower domestic competition due to the epidemic provided some respite).

Overall, given the impact of the epidemic in the second quarter and the relaxation of license restrictions, the incentive competition in the duty-free industry has temporarily entered a period of truce, so the competition pattern and profit situation for CDF this quarter should stabilize and rebound. However, in the medium to long-term, intensifying competition is still likely to be the main theme of the industry.

In addition, although the gross sales profit margin of the company significantly improved in the second quarter, its performance in controlling other expenses was not satisfactory. First, despite a sharp drop in revenue of 37%, the expenditure on administrative expenses remained at RMB 430 million, with little decrease on year-on-year (YoY) and quarter-on-quarter (QoQ) basis.

Furthermore, due to the large amount of goods purchased from overseas brands by CDF and the significant appreciation of the US dollar against the RMB, the company's financial expenses in the second quarter increased significantly to RMB 620 million. According to the detailed data disclosed in the semi-annual report, a total of RMB 470 million exchange losses were recognized in the first half of the year. Therefore, although the gross sales margin improved by nearly 5% in the second quarter, due to the nonrefundable management expenses and significant exchange losses, the net profit margin attributable to the parent company decreased significantly from 15.3% in the first quarter to 12.7% on a month-on-month basis. The net profit attributable to the parent company was RMB 1.4 billion, a decrease of 45%/46% year-on-year/month-on-month.

IV. Operating Data of Main Subsidiaries

In addition to the company's overall performance, the interim report also disclosed the operating data of its main subsidiaries, from which we can get a glimpse of the performance of the company's main sales channels.

Firstly, the revenue of Haimian in the first half of the year (including the stores in Bo'ao and Riyueguang) decreased by 55% year-on-year, indicating that the Hainan duty-free shopping was severely affected by the epidemic in the second quarter. The net profit was RMB 410 million, down 66% year-on-year, and the net profit margin also decreased from 15% to 12%.

The revenue of the Shanghai Airport channel represented by Rishang only decreased by 5% year-on-year, indicating that the online shopping performance of Rishang was good, which also corresponds to the increase in tax income compared with the same period last year. The net profit was RMB 482 million, down 54% year-on-year, and the profit margin dropped from 18% to 9%, indicating that the situation of insufficient increase in revenue and profit was also serious.

Dolphin's previous studies on China International Duty Free:

April 27, 2022, "The Reversal Time of China International Duty Free has not yet come under the Shadow of the Epidemic and the Intensified Competition"

April 23, 2022, "As the Revenue Deteriorates and the Profit Recovers, China International Duty Free is Still Going through a Test"

November 15, 2021, "The Curse Reappears? The future of China International Duty Free is still bright"

July 5, 2021, "Is China International Duty-Free (I) Just a Fool's Dream?"

Risk Disclosure and Disclaimer for this article: Dolphin Disclaimer and General Disclosure