SKSHU PAINT(603737)：IMPAIRMENT LOSS PROVISIONS AND EXPENSES WEIGH ON PROFIT; EXPENSE CONTROL TO BE CRUCIAL-格隆汇

机构：中金公司
研究员：Maoda YANG/Qing GONG/Yan CHEN

　　2023 and 1Q24 earnings miss market expectations
　　Skshu Paint announced its 2023 and 1Q24 results: In 2023, the firm’s revenue rose 10% YoY to Rmb12.5bn, and net profit attributable to shareholders fell 47% YoY to Rmb174mn, missing market expectation due to growing expenses, and credit and asset impairment loss provisions. In 1Q24, the firm’s revenue rose 1% YoY to Rmb2.07bn, net profit attributable to shareholders was Rmb47.08mn and recurring net profit was -Rmb77.24mn, missing market expectation due to high expenses.
　　In 2023, the firm recorded solid revenue growth with revenues from some product categories growing rapidly. The firm’s sales volume of home-decoration coating products rose 26%YoY to 0.43mnt and sales volume of engineering coating products fell 11% YoY to 1.19mnt in 2023, and its revenues from these two categories of products rose 3% and 10% YoY to Rmb2.6bn and Rmb4.7bn (vs. falling 6% YoY and growing 4% YoY in 4Q23). The firm’s revenues from adhesive products and auxiliary material products grew 30% and 41% YoY to Rmb761mn and Rmb2.42bn.
　　Gross margin recovered in 2023 thanks to falling raw material prices. The firm’s gross margin rose 2.6ppt YoY to 31.5% in 2023 (excluding taxes and surcharges), as the ASP for its purchases of emulsion and titanium dioxide fell 18% and 11% YoY.
　　Expenses rose considerably. The firm’s expense ratio rose 2.7ppt YoY in 2023, with selling and G&A expense ratios growing 1.7ppt and 0.7ppt YoY, mainly due to a 12% YoY increase in the number of employees (increasing to about 9,800).
　　Credit and asset impairment loss provisions weighed on profit. In 2023, credit and asset impairment loss provisions increased by Rmb106mn YoY to Rmb512mn, mainly due to loss provisions related to Evergrande, loss provisions for long-term accounts receivable, and home purchase impairment loss provisions.
　　Strong cash flows. In 2023, the ratio of cash received from sales of goods to revenue rose 7ppt YoY to 118%, driving net operating cash flow up by Rmb0.45bn YoY to Rmb1.41bn.
　　Debt-to-asset ratio declined. The firm’s net gearing ratio fell 40ppt YoY to 75% and debt-to-asset ratio fell 1ppt YoY to 81% in 2023
　　Demand under pressure but revenue stable in 1Q24. In 1Q24, the firm’s revenue edged up 1% YoY due to slow construction of projects and funding pressure. Revenues from home-decoration coating products, engineering coating products, adhesive products, and auxiliary material products rose 13% YoY, fell 16% YoY, grew 43% YoY, and rose 21% YoY in 1Q24,
　　Gross margin fell in 1Q24. In 1Q24, the firm’s gross margin fell 1.2ppt YoY to 28% as prices of emulsion and titanium dioxide rose 2% and 11% YoY.
　　Expense ratio rose. The firm’s overall expense ratio rose 3.7ppt YoY to 34% in 1Q24, as its selling and G&A expense ratios rose 3ppt and 1ppt YoY.
　　Cash flow remained strong. In 1Q24, the firm’s ratio of cash received from sales of goods to revenue was 135%, and net operating cash flow rose by Rmb0.2bn YoY to -Rmb264mn.
　　Trends to watch
　　Demand under pressure and competition intensifying; expense control to be crucial. In 2024, we believe completions of real estate projects will remain under pressure, but the firm could maintain steady revenue growth through distribution channel expansion, retail sales of higher-end products, and expansion of product categories (e.g., adhesive and auxiliary material products). We think raw material prices are bottoming out, competition is intensifying and product prices are falling, which may weigh on the firm’s gross margin. The increase in the number of employees drove up the firm’s expense ratio in 2023, and we think the firm needs to improve staff efficiency to reduce expense ratio and improve profit margin.
　　Financials and valuation
　　As demand is under pressure, we lower our 2024 net profit forecast by 39% to Rmb0.76bn. We introduce our 2025 net profit forecast of Rmb1bn. The stock is trading at 21x 2024e and 16x 2025e P/E. As the firm is an industry leader, we maintain our OUTPERFORM rating. Considering pressure on demand, we cut our target price by 50% to Rmb40, implying 28x 2024e and 21x 2025e P/E, offering 30% upside.
　　Risks
　　Disappointing demand recovery and/or expense control; worse-than- expected asset impairments; intensifying competition.