China Duty Free Group: Falling without a foreseeable bottom, can it start over again?

On the evening of March 28, $CTG DUTY-FREE(601888.SH) announced its 2024 annual report: the annual revenue reached 56.5 billion, a year-on-year decline of 16%, and the net profit attributable to shareholders was 4.27 billion, a year-on-year decline of 36%, with financial guidance continuing to show a shrinking trend. Since the basic performance situation was already disclosed in the previous performance announcement, Dolphin Research interpreted it from two angles: ① the latest changes in quarterly performance; ② the signals revealed by detailed data only disclosed in the semi-annual/annual report, as detailed below:

1. In terms of revenue, China Duty Free's revenue in Q4 2024 was 13.5 billion, a year-on-year decline of 19.5%, which is in the middle of the year-on-year decline range of Q2/Q3. There are no obvious signals indicating an expansion or narrowing of the decline.

Compared with industry data, the overall sales of duty-free in Hainan in Q4 declined by 21% year-on-year, which is a significant narrowing compared to a nearly 40% year-on-year decline in the previous two quarters, but the revenue growth rate of China Duty Free itself did not show signs of narrowing the decline. This indicates that in Q4, China Duty-Free may have lost market share in the Hainan duty-free market.

Combining with other indicators, the Hainan duty-free market shows that the customer flow for shopping is better than the sales revenue, which is dragged down by a significant decline in the average number of items purchased per customer (due to the impact of clearing purchasing agents). However, the decline in per capita consumption amount continues to narrow rapidly, now only at -3%. This suggests that there should be good progress in the upward movement of duty-free consumption brands and categories.

2. By income type, the year-on-year decline in taxable income (-26%) is still significantly higher than that of duty-free sales revenue (-16%), which is the main reason for the prolonged decline in the company's overall sales. Although we believe that taxable sales play a "firefighting" role during the pandemic, they will naturally fade as the core duty-free business recovers. However, taxable sales still account for nearly 32% of overall sales in 2H24, and if the decline cannot be stopped, the group's overall revenue will also struggle to stop declining.

The -16% decline in China Duty-Free's duty-free sales revenue is better than the overall -28.5% decline in Hainan's offshore duty-free during the same period. This is mainly due to the recovery of airport channel sales driven by the resurgence of outbound passenger flow. According to the company's disclosure, the duty-free revenue from Beijing Airport and Shanghai Airport channels increased by 115% and 32% year-on-year, respectively. However, since the scale of offshore duty-free is larger, the recovery of airport channels is not enough to fill the gap.

3. In terms of gross profit, in Q4, China Duty-Free achieved a gross profit of 3.8 billion, with the gross profit margin dropping from 32% in the previous quarter to 28.5%. The gross profit margin has declined for three consecutive quarters, and the decline is expanding. From the perspective of revenue types, the decline in the company's overall gross profit margin is mainly due to taxable business. In 2H24, the gross profit margin for taxable sales plummeted from 17.4% in the first half to only 8.9%. It is evident that when the company can complete the adjustment of taxable business will be a key turning point signal.

The gross profit margin for duty-free sales has remained stable at 39.5%, with almost no fluctuations. The company's pricing strategy for duty-free products seems to adopt a "cost + target gross profit margin" approach and assessment method. The overall change in the company's gross profit margin is entirely dependent on changes in the revenue structure and the gross profit margin of taxable sales.

Sales expenses for this quarter amounted to 2.27 billion, with expenditures in each quarter of the year fluctuating in a small range of 2.16 to 2.4 billion. The company's marketing expenditure budget should be relatively fixed, only experiencing very limited fluctuations with seasonal changes. Therefore, in the second peak season following the 1Q Spring Festival, although the total expenditure remained largely unchanged, marketing expenses passively shrank to 1.69 billion, a decrease of 1.5 percentage points compared to the previous season.

Overall, despite the gross profit margin being dragged down by taxable sales, resulting in a quarter-on-quarter drop of 3.5 percentage points, the seasonal growth in revenue volume means that the gross profit amount remained roughly stable quarter-on-quarter. The expenditure on marketing expenses also remained largely fixed. Therefore, the company's key operational profit indicator for this quarter -- the gross sales difference was 1.57 billion, which was almost unchanged compared to the previous season.

According to the semi-annual disclosure of sales expense composition, although the revenue from airport channels in 2024 has significantly recovered, the rental fees paid to airports have decreased from 9.42 billion last year to 9.06 billion. This reflects the benefits brought by the lower revenue-sharing terms re-signed by China Duty-Free Group with the airports. However, although this is currently a positive factor, it cannot be ruled out that with the further recovery of airport channels, the airport side may demand a re-adjustment of the commission ratio, turning the benefit into a negative.

In terms of expenses outside of marketing, at the year-end expense settlement point, management expenses have typically increased from 470 to 480 million in the previous few quarters to 590 million. Although this is a significant decrease compared to the 720 million spent in the same period last year, it is evident that the company has made some efforts to control costs and squeeze out profits, but it is far from enough. The year-on-year decline in management expenses is not as significant as the decline in revenue, resulting in an actual management expense ratio rising from 4.3% to 4.4% year-on-year, leading to a continued decline in profit margins.

In addition to the aforementioned impacts, this quarter also recognized an asset impairment loss of up to 350 million (mainly inventory impairment), whereas previously, most quarterly confirmations were between 100 to 200 million. Ultimately, net profit decreased from only 660 million in the previous quarter to just 550 million.

Moreover, the recently stronger airport channel is not fully owned by the company, leading to minority shareholder equity reaching 200 million, with the remaining net profit attributable to the parent company being only 350 million. For a company with a market value of 100 billion, this is merely "a drop in the bucket."8. From the perspective of dividends, the company announced a dividend of RMB 10.5 per 10 shares for this fiscal year, maintaining a dividend that corresponds to about 50% of the annual net profit attributable to the parent company. From this angle, the company is not stingy. However, compared to China Duty Free Group's market value still exceeding RMB 120 billion, the nearly RMB 2.2 billion in dividends corresponds to a rather limited shareholder return.

Dolphin Research Perspective:

The performance of China Duty Free Group this time can be summed up in one sentence: as everyone knows, it is poor, with revenue continuing to decline, and the speed of decline has not shown significant improvement. The quarterly profit has fallen below RMB 500 million, which is completely incompatible with China Duty Free Group's market value of over RMB 1 trillion. However, as stated, these situations were already clear in the performance report released in January.

From the complete annual report, the incremental information we see is that the taxable sales business launched during the pandemic, which was initially a "firefighter," has now become the "culprit." In contrast, although the duty-free business is still experiencing negative growth due to the significant drag from offshore duty-free sales, with the recovery of channels such as airports and the arrival of a low base period for offshore duty-free sales, it should be able to exit the negative growth mire more quickly. Moreover, on the profit side, the gross profit margin of duty-free sales is relatively stable, primarily affected by taxable sales. Therefore, monitoring when taxable sales can stabilize is a key turning point signal.

In terms of valuation, after more than two years of continuous adjustment starting from the end of 2022, and following the valuation recovery of assets across China at the end of September last year, China Duty Free Group's current market value of approximately RMB 127 billion (A-shares) corresponds to nearly 30x PE based on the announced net profit for 2024. (The valuation of Hong Kong stocks is about 3/4 of A-shares, approximately 22x PE). From an absolute value perspective, a 30x PE matching still reflects deeply underwater performance (both revenue and profit declining), which is not cheap.

However, in the A-share market, consumer leaders with a certain market monopoly position are generally not stingy with valuations. The current valuation of around 30x is close to the company's average level over the past 10 years. The valuation of about 20x PE before the major rebound in September last year can be regarded as a reference for the bottom of China Duty Free Group's valuation.

Looking ahead, Wind's consensus expectations show that sell-side expectations for the company's profits in 2025 are around RMB 6 billion. It can be seen that the market's current valuation of China Duty Free Group is based on a 20x PE valuation floor * current profit expectations for 2025. Further room for valuation reduction should also be limited, and the subsequent stock price trend will depend on whether the actual delivered profit is lower or higher than RMB 6 billion.

In terms of performance trends, China Duty Free Group's revenue is expected to continue declining in 2024, mainly due to the overall continued shrinkage of the Hainan duty-free market. This should be influenced by the normalization of inbound and outbound travel, the weakening of overall domestic discretionary/luxury consumption, and the decline in preference for overseas cosmetics brands amid the rise of domestic products.

The diversion of outbound shopping, with the recent restoration of international flight volumes to 80%, is likely to gradually weaken in the future. However, whether there will be improvement in the latter is something Dolphin Research believes should not be overly optimistic about. The current pricing implicitly requires that the performance in 2025 must rebound from the bottom, which is not sufficiently secure detailed comments are as follows:

1. Per capita consumption of offshore duty-free is close to returning to positive, but the turning point for sales amount has not yet arrived

In terms of revenue, China Duty Free's revenue in Q4 2024 was 13.5 billion yuan, a year-on-year decline of 19.5%, which is in the middle of the year-on-year decline range of Q2/Q3. In other words, there is no clear tendency for the decline to continue to expand or to narrow.

Regarding the overall situation of Hainan's offshore duty-free, the overall sales in Q4 decreased by 21% year-on-year, which is a significant narrowing compared to the nearly 40% year-on-year decline in the previous two quarters. However, the revenue growth rate of China Duty Free itself has not shown signs of narrowing the decline. This indicates that China Duty Free may have lost market share in Hainan's duty-free market in Q4.

Combining other indicators sorted by year-on-year decline from good to bad, the situation shows that per capita consumption amount > number of shoppers > sales amount > number of items purchased per capita. In other words, the flow of shoppers is performing better than sales, which is dragged down by a significant decrease in the average number of items purchased per customer (due to the impact of clearing purchasing agents). The positive aspect is that the decline in per capita consumption amount continues to narrow rapidly, now only at -3% this season. This suggests that there should be good progress in the upward trend of duty-free consumption brands and categories (such as high-ticket luxury goods, bags, jewelry, etc.), and it cannot be ruled out that the consumption capacity/willingness of duty-free consumers is close to bottoming out and rebounding.

2. When will the tax burden ease? The recovery of airport channels cannot save Hainan channels

According to the semi-annual disclosed revenue by type, the year-on-year decline in taxable revenue (-26%) is still significantly higher than that of duty-free sales revenue (-16%), which is the main reason for dragging down the overall sales decline of the company. This aligns with our judgment that taxable sales were a "stopgap" business launched during the pandemic to make up for the gap in duty-free business. It will naturally fade away as the core duty-free business recovers.

However, taxable sales still accounted for nearly 32% of overall sales in 2H24, and if the decline cannot be stopped, the group's overall revenue will also struggle to stop declining and rebound. According to the company's disclosure, the taxable commercial buildings in Sanya and Haikou International Duty-Free City have reached structural completion, and with these properties coming into operation, it may promote the stabilization of taxable sales.

Looking solely at the -16% decline in China Duty Free's duty-free sales revenue is better than the overall Hainan offshore duty-free's -28.5% year-on-year decline, which is mainly attributed to the recovery of airport channel sales with the resurgence of inbound and outbound passenger flow. According to the company's disclosure, in 2024, the duty-free revenue from the Beijing airport channel and the Shanghai airport channel increased by 115% and 32% year-on-year, respectively. However, the duty-free volume from offshore sales is larger, and the recovery of the airport channels is not sufficient to drive a rebound in the group's overall sales.

Third, the gross profit from duty-free sales has remained unchanged for three years, while the gross profit from taxable business revenue has dragged down both ends.

In the fourth quarter, China Duty Free Group achieved a gross profit of 3.8 billion, with a gross profit margin dropping from 32% in the previous quarter to 28.5%. The gross profit margin has declined for three consecutive quarters, and the decline is expanding.

By revenue type, the overall decline in the company's gross profit margin is mainly due to the drag from taxable business, with the gross profit margin for taxable sales in 2H24 plummeting from 17.4% to only 8.9%. It is evident that when the company can complete the adjustment of its taxable business will be a major turning point signal.

In contrast, the gross profit margin for duty-free product sales has remained stable at 39.5%, showing almost no fluctuation. The company seems to adopt a "cost + target gross profit margin" pricing strategy and assessment method for duty-free products. The overall change in the company's gross profit margin is entirely dependent on changes in the revenue structure and the gross profit margin of taxable sales.

Fourth, marketing expenses remain unchanged, and the decline in airport commissions contributes significantly.

Sales expenses for this quarter were 2.27 billion, with quarterly expenditures fluctuating in a small range of 2.16 to 2.4 billion throughout the year, indicating that the company has adopted a relatively fixed marketing expenditure budget plan, with very limited fluctuations up and down, only varying slightly with seasonal changes. The expense ratio thus changes passively with the overall revenue volume during peak and off-peak seasons. As the second peak season after the Spring Festival in Q1, the marketing expense ratio has passively contracted to 16.9%, a decrease of 1.5 percentage points from the previous quarter.

Therefore, although the overall gross profit margin this quarter has dropped by 3.5 percentage points due to the drag from taxable sales, due to the seasonal quarter-on-quarter growth in revenue volume, the gross profit amount has remained roughly stable quarter-on-quarter. The marketing expenses also have a largely fixed expenditure budget, showing almost no change. This quarter, the company's gross sales difference was 1.57 billion, which is almost unchanged compared to the previous quarter. Dolphin Research boldly speculates that at least in the second half of 2024, China Duty Free Group is likely to assess absolute profit amounts without strict requirements on profit margins.

According to the semi-annual disclosure of sales expense composition, although the revenue from the airport channel in 2024 has significantly recovered, the rental fees paid to the airport have slightly decreased compared to last year, from 9.42 billion to 9.06 billion. This reflects the benefits brought by the lower revenue-sharing terms that China Duty Free Group (CDFG) renegotiated with the airport.

However, although this is currently a positive factor, it cannot be ruled out that with the further recovery of the airport channel, the airport may demand a re-increase in the commission rate, turning the positive into a negative.

V. Cost control efforts are far from enough, with quarterly profits falling below 500 million

In terms of other expenses, at the year-end settlement point, management expenses have significantly increased from the previous few quarters' 470-480 million to 590 million. This is a considerable decrease compared to the 720 million spent in the same period last year, indicating that the company has made some efforts to control costs and squeeze out profits, but it is far from enough. The year-on-year decline in management expenses is not as significant as the decline in revenue, resulting in an actual management expense ratio rising from 4.3% to 4.4% year-on-year, leading to a continued decline in profit margins.

Ultimately, due to the gross sales difference delivered by the operating level being merely flat quarter-on-quarter at nearly 1.6 billion, and the company's cost control efforts being far from sufficient, other operating expenses outside of marketing increased by approximately 80 million quarter-on-quarter during the year-end settlement season. Additionally, this quarter recognized a substantial asset impairment loss of up to 350 million (mainly inventory impairment), whereas previously, most quarters recognized 100-200 million. Therefore, the net profit fell from only 660 million in the previous quarter to just 550 million.

Moreover, since the recently stronger airport channel is not fully owned by the company, after excluding the 200 million benefits to minority shareholders this quarter, the net profit attributable to the parent company is only about 350 million. For a company with a market value of 100 billion, a quarterly profit of less than 500 million is concerning