We maintain an optimistic view of Maoye International as the first quarter results of its major subsidiaries show that operating expenses and financial costs are better than expected. We expect that the trend for the better will continue and our forecasts for the department store business may be conservative. We also expect continued property sales to boost core earnings by 21 per cent in 2013 and free cash flow to become positive. The stock now trades at 8.6 times 2013 forward earnings, a 40% discount to its peers, and has an attractive valuation.
Support the main points of rating
Core net profit rose 10% in the first quarter, better than expected. Maoye Mall, the main subsidiary of Maoye International, announced a net profit of 184 million yuan in the first quarter, an increase of 10 percent over the core net profit of 166 million yuan (excluding disposal income of 130 million yuan) in the same period last year. In view of the 5.3% increase in same-store sales in the department store business in the first quarter, we believe that the profit growth faster than the same-store sales growth is mainly due to the effective control of sales and management expenses, the reduction of financial costs and the reduction of losses in the real estate business. these factors are better than we expected.
Our 2013 forecast for the department store business may be conservative. We expect the core profit of the department store business to grow by 4% and same-store sales to grow by 7.8% in 2013. In view of the fact that the growth rate of earnings in the first quarter outpaced the growth rate of same-store sales, we believe that our full-year profit forecast is relatively conservative, and it is expected that the decline in operating costs and financial expenses may lead to further profit growth. Judging from the same-store sales growth rate since the beginning of the year (high number of units in April, 5% in the first quarter), we should be able to meet our full-year target.
Real estate business will drive earnings growth. We expect the real estate business to turn a profit and contribute 4% of 2013 earnings (- 10% in 2012), which will drive core earnings per share growth of 22% in 2013. Our assumptions about the profit margin of the real estate business are also conservative, so even if the delivery time of the Taiyuan project is postponed to 2014, we expect only 5% downside in the 2013 profit forecast, while 2014 profits will have greater upward potential.
Cash flow improved. Free cash flow narrowed to-334 million yuan in the first quarter from-706 million yuan in the same period last year. We think this is mainly due to the increase in cash flow from real estate sales. With the improvement in cash flow, the company has spent HK $218 million to buy back 2.3 per cent of outstanding shares since March. In view of the continued cash flow of property sales, we expect free cash flow to become positive in 2013.
Main risks faced by rating
Same-store sales growth and real estate sales fell short of expectations.
Valuation
Our target price of HK $1.90 is based on segment plus aggregate valuation, which includes a retail business valuation of HK $1.80 per share (10 times expected 2013 earnings) and a real estate business valuation of HK $0.10 per share (60% discount on net assets per share). Our target price corresponds to 10 times 2013 forward price-to-earnings ratio.