The decline in 2023Q2's revenue has narrowed, and at the same time as store adjustments, high amounts have been calculated, putting pressure on the profit side losses.

Customer orders are steady and passenger flow is under pressure, yet the company sticks to its brand and original intentions, focuses on “expression of love”, continues to promote brand building and expand categories. 23H1 has made major adjustments to optimize low potential stores, improve operational capacity, and optimize organizational management. Currently, the company has sufficient capital, and there is still plenty of room for expansion after the adjustments are completed. The company was given 29xPE in 2024, corresponding to a target price of 38 yuan, and adjusted to the “increase in holdings” rating.

The decline on the revenue side narrowed, and losses on the profit side were under pressure due to impairment of assets accrued by stores. 23H1 achieved operating income of 1,242 million yuan/ -40.5%, net attributable profit of 53 million yuan/ -90.8%, net net profit of non-attributable net profit of 49 million yuan/year-on-year transfer of negative, and net operating cash flow of 41 million yuan/ -91.2%. The actual performance of this announcement is at a low level in the predicted performance range. 23Q2 The company achieved operating income of 537 million yuan/ -37.9%, net attributable profit - 48 million yuan/year on year to negative, net profit after deducting non-attributable net profit - 100 million yuan/year on year to negative, and net operating cash flow - 52 million yuan/year over year. As of the end of 23H1, there were 534 million yuan in on-hand cash and 4,540 billion yuan in transactional financial assets, and the ability to continue to operate steadily.

Customer orders are steady and passenger flow is under pressure, enhancing image and expanding categories around “expression of love”. ① Product: Revenue from both categories is under pressure, and profit is declining. 23H1's revenue from marriage proposal rings and wedding rings was 964 million yuan/ -41.7%, 261 million yuan/ -33.3%, respectively. The gross margin was 72.0% /-0.3ppt and 60.4% /-8.5 ppts, respectively. Weak terminal demand has put pressure on both categories of revenue. The gross margin has stabilized and the diamond ring has declined. ② Passenger flow: The unit price of customers is stable, and the number of passengers has declined significantly. The 23H1 average customer unit price is about 11,000 yuan/person, +3.5%, and the number of customers is about 113,000, or -42.39%. The company adheres to brand positioning and rarely takes discount promotion measures. The customer unit price is relatively stable, but weak demand has put pressure on passenger traffic. ③ Brand: image enhancement, category expansion. 23H1 continues to focus on the core concept of “Expression of Love” and carry out activities such as the Global 100 Diamond Wedding and the 520 Proposal Season to enhance its brand image. At the same time, the company also launched new products such as DR Xiaojinxin and the Intangible Heritage Filigree Gold Package to explore new scenarios of “expression of love” in the new gold category. ④ Management: Organizational optimization promotes efficiency improvement. The company announced that according to the board resolution of August 25, the company appointed Ms. Lu Yiwen as the company's general manager. The optimization of the organizational structure is expected to further promote the improvement of operating efficiency.

Channel strategy adjustment to optimize low potential stores. 23H1 offline direct management revenue is 1,017 billion yuan/ -39.5%, and gross margin is 70.0% /-2.1 ppts. Weak demand puts pressure on offline direct-run store operations. Among them: ① Quantity: Optimize low potential stores, with more adjustments in Tier 1 and 2. By the end of 23H1, the number of directly-managed stores had reached 621, a net decrease of 10 from the end of 2022. Among them, there were -12 and +2 in Tier 1 and 2 cities respectively. The company adjusted its channel strategy and replaced low potential stores. Among them, stores in Tier 1 and 2 cities were adjusted even more. ② Store efficiency: Weak demand and diversion from new stores have reduced store efficiency. 23H1 compared to 22H1 and 21H1, the revenue of direct-managed stores was -56.4% and -71.6% respectively, the profit efficiency was -57.8% and -73.4% respectively, and the gross margin was -2.1 ppts and -1.0ppt respectively. The reason was that, on the one hand, sales declined due to weak demand; on the other hand, it diverted existing store revenue after the number of stores increased, and 23H1 direct-run store CR5 revenue accounted for -1.1 ppts year-on-year. ③ Response: Stores with poor performance accrue asset impairment. Affected by fluctuations in demand, the performance of some new stores opened in 2022 was poor. The company reduced the value of 104 stores during the 23H1 period, resulting in asset impairment losses of 55 million yuan. In addition, in terms of other channels: ① Online self-employment: the share of third parties has increased, and the number of customers on the official website has declined. 23H1 Online self-operating revenue is 122 million yuan/ -43.9%, gross profit margin is 67.21% /-1.9 ppts, of which the revenue share of third-party platforms is +1.7 ppts, and the unit price of official website visitors is 0.58 million yuan/ -7.9%; ② Offline partnership: The number of stores is steady, and the efficiency of a single store is declining. 23H1's offline joint venture revenue was 101 million yuan/ -37.3%, gross profit margin was 67.8% /-2.8ppts. As of the end of 23H1, the number of affiliated stores was 55, a net decrease of 2 from the end of 2022, and single-store revenue was -51.6%.

Weakening of the scale effect compounded by an increase in expenditure, and increased sales rates put pressure on profit margins. 23H1 achieved a gross profit margin of 69.3% /-1.3 ppts, of which 23Q2 had a gross profit margin of 68.5% /-2.1 ppts. In terms of cost rates for the period, 23H1 and 23Q2 sales expense rates were 55.9% /+23.9 ppts and 65.2% /+33.3 ppts, respectively. On the one hand, the company maintained large-scale brand promotion expenses, and the rate increased after the scale effect weakened; on the other hand, new store development brought an increase in expenses such as wages, remuneration, depreciation and amortization, etc. The management fee rates for 23H1 and 23Q2 were 6.2% /+2.5 ppts and 6.0% /+2.4 ppts, respectively. The increase in the rate was mainly due to a weakening of the scale effect, an increase in wages and remuneration, and an increase in the cost of consulting services for professional institutions. The R&D expense rates for 23H1 and 23Q2 were 1.6% /+0.7ppt and 1.7% /+1.2ppts, respectively, and the financial cost rates were 1.0% /+0.9 ppt and 1.3% /+1.1 ppts, respectively. Affected by the weakening of gross margin and the increase in the cost ratio, the net profit margin attributable to 23H1 and 23Q2 companies was 4.3% /-23.4 ppts and -8.9% /-32.3ppts, respectively.

Risk factors: The weak recovery in consumption after the epidemic led to insufficient demand for high-priced products; strong demand for gold replaced diamonds; large fluctuations in diamond prices affected demand; store operations that fell short of expectations led to increased impairment accruals; and the impact of brand marketing expenses fell short of expectations.

Profit forecasting, valuation and ratings: 2023Q2's revenue decline has narrowed, and at the same time as store adjustments, high accruals have been made, putting pressure on profit side losses. Customer orders are steady and passenger flow is under pressure, yet the company sticks to its brand and original intentions, focuses on “expression of love”, continues to promote brand building and expand categories. 23H1 has made major adjustments to optimize low potential stores, improve operational capacity, and optimize organizational management. Currently, the company has sufficient capital, and there is still plenty of room for expansion after the adjustments are completed. Considering the company's focus on optimizing operating efficiency and store adjustments, assuming that the company's revenue scale in 2024 grew slowly compared to 2023 and net interest rate recovered to pre-pandemic levels, we lowered the company's 2023/24/25 EPS forecast to 0.27/1.32/1.75 yuan (the original forecast was 2.17/3.06/3.52 yuan), and the current price corresponds to 124.9/25.9/19.5 times the PE in 2023/24/25. Optimistic about the company's operating adjustments and profit optimization, with reference to Chow Tai ?$#@$, a comparable company with strong brand power in the gold and jewelry industry, is about 16 times in 2024 (predicted by the CITIC Securities Research Department). Considering that the company has plenty of cash on hand, although it is currently in a period of business adjustment, there is still plenty of room for expansion after the adjustment is completed. At the same time, the company's brand premium is strong and there is a discount in Hong Kong stock valuations. It was given 29xPE in 2024, corresponding to a target price of 38 yuan in 2024, and downgraded to a “increase in holdings” rating.