Revenue fell 7.5% in the first quarter, and gross margin remained essentially flat. In the first quarter of 2024, due to weak offline traffic, revenue was -7.5% YoY to 5.40 billion yuan; net profit to mother was -20.9% YoY to 170 million yuan.

Gross margin fell 0.3 percentage points to 33.2% year on year. The negative factors were mainly due to changes in channel structure, and the share of franchise channels with lower gross margin increased. However, on the other hand, direct store discounts improved the lower number of units year over year, offsetting the negative impact of channel combinations on gross margin to a certain extent. Based on proper cost management and streamlining of inefficient stores, employee costs and rent expenses fell. The total number of people decreased 14% year over year, sales and management expenses remained flat +0.2 percentage points year on year, respectively, and net interest rate to mother fell only 0.6 percentage points.

Inventories have declined markedly, turnover has increased, and cash levels have increased. Based on an omnichannel hub plan for efficient inventory sharing with brand partners, etc., the company effectively improved inventory management efficiency. At the end of the first quarter of 2024, the number of inventory turnover days was 119 days, a decrease of 17 days over the previous year. The inventory level dropped 16.9% year on year, and the proportion of old inventory was less than 9%. Based on improved working capital turnover efficiency and reduced debt levels, cash inflows of 540 million yuan and own cash flow of 380 million yuan. Cash at the end of the period increased 6.7% from the beginning of the period to 3.07 billion yuan.

Under refined offline management, efficiency increased by double digits month-on-month, and omni-channel growth was steady under digital transformation. 1) Double digit increase in floor efficiency. In the first quarter, 42 of the company's directly-managed stores closed to 3,481, with a year-on-year increase of 2 percentage points to 21%, the same as the end of 2023; total sales area decreased by 2 percentage points year on year, but the average number of units in the year-on-year increase in store area was the same as at the end of 2023; the average store's monthly yield and floor efficiency fell by medium to high units year on year, increasing double digits from month to month; sales at the same store were -16.5% year-on-year, mainly affected by a drop of nearly 35-40% in customer flow. 2) Steady omnichannel growth: Omnichannel maintained steady growth, partially offsetting the impact of fluctuations in offline traffic. Omnichannel overall was +3% year-on-year, accounting for 26% of total revenue, up 2 percentage points year-on-year. Among them, the Pan-WeChat ecosystem is becoming increasingly important as a private traffic channel, mainly covering WeChat stores, Douyin live streaming, and shopping mall membership platforms. Pan-WeChat stores in the first quarter were -18% year-on-year due to controlling discount drainage; at the same time, the company strategically increased public channel sales (mainly including third-party platforms Tmall, JD Vipshop, etc.), +23% over the same period last year. 3) Recent performance:

Net operating income for April was 1.62 billion yuan, -12.3% year-on-year; the cumulative year-on-year decrease in January-April was 8.6%.

Risk warning: Consumption recovery falls short of expectations; supply chain logistics are blocked; channel optimization reforms fall short of expectations.

Investment advice: Optimistic about short-term profit improvements and the sustainability of medium- to long-term growth momentum. Sales revenue declined in the first quarter of 2024 due to environmental changes, mainly negatively affected by changes in channel structure, but at the same time, gross margin remained stable; operating quality was good, efficiency continued to improve month-on-month, steady omni-channel growth, inventory turnover and working capital turnover efficiency improved, and cash levels rose. Looking ahead to the next three years, profitability will continue to improve. We maintain our profit forecast. We expect net profit of 2024-2026 to be $58/7.3/890 million, +19%/25%/22% year over year, maintaining a reasonable valuation range of HK$0.77 to 0.88, corresponding to 6-7x PE in 2024, maintaining a “buy” rating.