M&G STATIONERY(603899)：EARNINGS UNDER PRESSURE AMID COVID-19 IN 1H22;LIKELY TO IMPROVE QOQ IN 3-4Q22

　　1H22 results largely in line with our expectations

    M&G Stationery announced its 1H22 results: Revenue grew 9.7% YoY to Rmb8.43bn, attributable net profit fell 20.6% YoY to Rmb529mn, and recurring attributable net profit dropped 21.0% YoY to Rmb484mn, largely in line with our expectations. Revenue increased 10.9% YoY in 1Q22 to Rmb4.23bn and 8.5% YoY in 2Q22 to Rmb4.21bn, and attributable net profit fell 16% YoY in 1Q22 to Rmb276mn and 25.1% YoY in 2Q22 to Rmb253mn.

    　　Trends to watch

    　　1H22 revenue under short-term pressure amid COVID-19 resurgence and logistics disruptions; Colipu maintained robust momentum. The COVID-19 resurgence in Shanghai (where the firm’s headquarters and production bases are located) weighed on the firm’s business operations. Specifically, revenue from the traditional stationery business (including the consolidated AXUS) fell around 15% YoY to about Rmb1.58bn, and revenue from subsidiary M&G Technology fell 5% YoY to Rmb120mn. By category, revenue from writing instruments and school stationery declined 35.1% and 0.2% YoY in 2Q22, while that from office stationery increased 6.2% YoY. We attribute this to declining sales of self-produced core products caused by logistics disruptions amid COVID-19. Subsidiary Beckmann booked revenue of Rmb90mn in 1H22. Revenue from major retail stores fell about 32% YoY to around Rmb165mn in 2Q22. The number of M&G Shop stores totaled 481 at end-2Q22, registering a net increase of nine. The COVID-19 resurgence weighed on offline customer traffic. We expect the firm’s retail business to recover after the COVID-19 pandemic eases. Revenue from its office stationery business Colipu rose 28% YoY to Rmb2.26bn in 2Q22. The firm has acquired many high-quality customers such as China Southern Airlines and China Huaneng while expanding its presence in new segments such as maintenance, repair and operations (MRO). We expect the firm to have ample order backlog and maintain rapid growth amid COVD-19 headwinds.

    　　Declining capacity utilization rate to weigh on gross margin in the short term; expense control strong. Gross margins of writing instruments, school stationeries and office stationeries fell 2.1ppt, 1ppt, and 2.3ppt YoY in 2Q22. We think the gross margin of the firm’s core traditional businesses will likely fluctuate in the short term due to a declining capacity utilization rate caused by COVID-19. This, coupled with the rising revenue contribution from Colipu, drove down the firm’s blended gross margin by 4.1ppt YoY to 19.3% in 2Q22. Selling, G&A and R&D, and financial expense ratios fell 0.2ppt, 0.2ppt, and 0.4ppt YoY to 7.2%, 5.4%, and -0.3%, showing the firm’s strong expense control. Net margin dropped 2.7ppt YoY to 6% in 2Q22.

    　　Upbeat on medium to long term growth prospects; earnings to improve QoQ. We think the firm’s traditional stationery business enjoys strong competitive advantages. The firm continues to advance its product premiumization strategy and build an omnichannel distribution network. As inventories at distributors decline amid easing COVID-19 impact, we expect the firm’s traditional stationery business to regain positive growth starting from 3Q22. Colipu will likely continue to acquire large clients, with profitability improving steadily. We expect the firm’s store productivity to recover thanks to the optimization of product mix, improvement of operational capacity, and recovery of customer traffic at its retail stores.

    　　Financials and valuation

    　　Given the COVID-19 impact, we lower our 2022 and 2023 earnings forecasts 19% and 11% to Rmb1.44bn and 1.90bn. The stock is trading at 27x 2022e and 20x 2023e P/E. Based on our earnings forecast revisions, we maintain OUTPERFORM and cut our TP 12.5% to Rmb56 (36x 2022e and 27x 2023e P/E), offering 35% upside.

    　　Risks

    　　Sharp fluctuations of raw material costs; new business model disappoints; policy uncertainty.