ZHOU HEI YA(01458.HK)：EARNINGS UNDER SHORT-TERM PRESSURE FROM COVID-19;AWAITING A RECOVERY-格隆汇

机构：中金公司
研究员：Wendan WANG/Yunpeng FANG/Wenbo CHEN

　　What's new
　　We recently attended Zhou Hei Ya’s shareholder meeting, invited its management to attend the CICC Investment Strategy Conference 2H22, and spoke with its senior executives.
　　Comments
　　Store expansion on track; 1,000 stores to be added in 2022. Our grassroots survey shows that Zhou Hei Ya opened about 450 stores from January to May. Despite the COVID-19 resurgence in April, the company opened more than 140 new stores, of which 88 are franchise stores. Community-based stores that require small investment and help save cost amid COVID-19 resurgence are preferred by franchisees. In February, the company started the nationwide expansion of community-based stores. In April, it opened 68 new community-based stores. We expect the company to accelerate the expansion of its community-based store network and open around 500 new stores in 2022, bringing the cumulative number to about 700. According to our grassroots surveys, the company’s franchise store closure rate remains manageable despite the impact of the COVID-19 resurgence in 2022. Overall, the company’s store expansion is well on track, and we expect it to add about 1,000 stores in 2022.
　　COVID-19 weighing on efficiency of stores with high growth potential; joining hands with franchisees to overcome challenges. Our grassroots survey shows that traffic flow at transportation hubs has plunged since February due to COVID-19 resurgence, weighing on efficiency of Zhou Hei Ya’s stores located at such hubs. Meanwhile, roadside stores and stores located in business districts were also pressured. Self-operated stores saw profit decline due to the operational leverage effect. Franchisees also faced pressure amid COVID-19 resurgence, as it took longer than usual for them to generate return on investment (but still better than tea or food businesses). According to our survey, the company has recently taken initiatives to help franchisees open and renovate stores, reduce security deposits, and waive royalties. These initiatives may weigh on the company’s profit in the short term, but will likely support the sustainable development of its franchising business in the medium to long term, in our view.
　　Promoting new products; profit under pressure in the short term; earnings to gradually recover as COVID-19 eases. Our grassroots survey shows that the company continues to promote new products since the successful launch of shrimp balls in May 2021 (shrimp balls have boosted its monthly sales performance). We expect the company to increase investment in new products such as shrimp balls to improve sales of its stores. According to our grassroots survey, despite rising costs, the company's gross margin (GM) grew in 1Q22 thanks to price hikes and improving supply chain efficiency. We expect its 2H22 GM to grow or drop by low single digits. We think the company's 1H22 profit may come under pressure or be meager amid COVID-19 resurgence. Looking ahead, we still see uncertainties in profit growth amid the pandemic. We think its profit may recover if the impact of the COVID-19 eases in 2H22 and 2023.
　　Financials and valuation
　　We estimate the company’s 2022 and 2023 revenue will rise 0.2% and 44.7% YoY to Rmb2.88bn and Rmb4.16bn. Given the impact of COVID-19 resurgence on the company’s self-operated stores, we lower our 2022 and 2023 net profit forecasts 52.8% and 3.8% to Rmb134mn (-61% YoY) and Rmb466mn (+248% YoY). Zhou Hei Ya is trading at 18x 2023e P/E. Considering the company's earnings may gradually recover from the COVID-19 resurgence, we maintain our target price at HK$5.2 (22x 2023e P/E with 22.4% upside). We maintain OUTPERFORM.
　　Risks
　　Uncertainty due to COVID-19 resurgence in China; store network expansion disappoints; surging costs; tepid demand.