Gome Retail issued a profit warning and expects revenue from home appliance sales to fall about 40 per cent in the first half from a year earlier, with a net loss of 2.5 billion to 3 billion yuan.

With the strategic partnership between Gome and JD.com and Pinduoduo, the company's GMV on these two platforms increased more than 100 times in the first half of 2020 compared with the same period last year.

Gome cut its sales and management expense ratio by 25 per cent in the first half to reduce losses.

Gome issued a profit warning on August 7.

As a result of the COVID-19 epidemic, more than 90 per cent of Gome's offline stores were temporarily closed, so home appliance sales fell 60 per cent in the first quarter of fiscal year compared with the same period a year earlier. Due to the explosive growth of online channels and community group buying, coupled with the lifting of restrictions on the installation of household appliances, the decline narrowed to 16% in the second quarter of fiscal year 20.

As high-margin home appliance sales were affected by COVID-19 's epidemic, gross profit margin was about 10 per cent in the first half of fiscal year, down 4.55 percentage points from a year earlier, and 58 per cent in the first quarter of fiscal year. Gross profit margin returned to 12-13% in the second quarter of fiscal year 20. The company's gross profit margin rose to 14-15% in June and 15-16% in July. Including the one-time gain of 304 million yuan earned by COVID-19 during the epidemic, the net loss of Gome in the first half of fiscal year 20 is expected to be 2.5 billion to 3 billion yuan, and the net loss in the first half of fiscal year 19 is 380 million yuan, which is worse than our expectations. Management said 85% of 80% of the loss came from the first quarter of fiscal year 20.

Online channels show vitality

The GMV of Gome APP and Gome community grew by more than 70 per cent year-on-year, and the number of communities grew by more than 40 per cent year-on-year, reaching 65 per cent year-on-year growth in users. Gome uses the O2O strategy of "one store, one page" to achieve a year-on-year increase of more than 150% in sales conversion rate. Through the successful introduction of JD.com and Pinduoduo as strategic partners in April and May, Gome's GMV on these two platforms increased more than 100 times year-on-year in the first half of fiscal year 20. JD.com contributed RMB 2 billion in GMV and RMB 1 billion in sales during the period, with a gross profit margin of 14-15 per cent in June. Pinduoduo contributed Rmb30 to Rmb4 billion in GMV and Rmb2 billion in sales, with a gross profit margin of 5Rmb8 per cent in June. Management expects JD.com and Pinduoduo's GMV to reach 10 billion yuan each in the second half of the fiscal year, while full-year sales of the two platforms will reach 12 to 14 billion yuan. At present, the average prices of offline stores in JD.com, Pinduoduo and Gome are about 3000 yuan, 1500 yuan and 5000 yuan respectively. Management expects double-digit revenue growth in the second half of fiscal year 20.

Continue to cut bottom costs in the second half of FY20

Gome's sales and management expense ratio fell by 25% in the first half of fiscal year 20, mainly due to a drop in rents guided by government policies during the COVID-19 epidemic. As Gome's offline stores and landlords renegotiate the terms of the lease, overall rental spending will fall by 15% year-on-year in the second half of fiscal year, 10-15% year-on-year in the next 1-3 years, and 5-10% in the next eight years. Through personnel optimization, salary expenditure is expected to fall by 15% in the second half of fiscal year 20.

Gome plans to cut its sales and marketing expenses by 20% in the second half of the fiscal year, thanks to free user traffic from Pinduo, JD.com 's low-cost user traffic and user traffic from its own community. Gome expects debt restructuring to optimize financial costs after positive operating cash flow returns in the second half of fiscal year 20, and Gome expects its overall expenditure rate to fall by 15% or more in the second half of fiscal year 20.

Reiterate Gome's "downgrade" rating

We expect Gome to return to positive net profit only in fiscal year 21. The company's strategic cooperation with JD.com and Pinduoduo is of positive significance, but the real impact depends on its detailed implementation plan. We believe that Gome still needs time to produce synergies for its online and offline combinations. The positive drivers are better-than-expected cost control and faster-than-expected sales growth of household appliances. Risks include the COVID-19 epidemic and the more serious impact caused by the failure of the reform.