Report highlights

Looking at national policy in the long term: consumption is returning, and the cake is growing bigger

The tax-free competition pattern is orderly, and policies increase the return of consumption. Consumption of duty-free goods in China is an important driving force in guiding the return of consumption. The long-term positive trend of China's economy has not changed, and the people's demand for high-quality consumption will continue to be released. Hainan's “14th Five-Year Plan” duty-free industry development goal is to attract the return of duty-free shopping to 300 billion yuan, and duty-free trade on the outlying islands has doubled to expand the cake together.

Looking at the pattern in the medium term: leading retail barriers are extremely strong

The duty-free industry determines the conversion rate and bargaining power of entry into stores by the effect of scale, and builds a moat for enterprises. China's free travel history can be traced back to 1984. With a central enterprise background and strong travel resources, the company became the world's largest travel retail operator in 2020 and ranked first for three years. By the end of 2023, China Free will set up about 200 duty-free shops, covering more than 100 cities. According to Sullivan's report, China's duty-free domestic sales accounted for more than 85% after 2018, followed by sea travel duty-free (9.3%), and China's duty-free industry showed a strong pattern. At the same time, the company has accelerated the development of online taxable business and has achieved revenue growth over the past few years.

Looking at profit in the short term: Airport declines this week, the pace is picking up

A supplementary airport rent agreement was signed, and both guarantees and deductions were reduced. At the end of 2023, the company signed rent supplement agreements with Shanghai and Capital Airport. The guaranteed rent dropped sharply (707 million yuan for Shanghai Airport, 558 million yuan for Capital Airport), far lower than before 2021 (Shanghai Airport about 6 billion yuan, Capital Airport about 3 billion yuan), and the comprehensive deduction rate dropped from about 45% in 2019 to about 28%-32%. If international passenger traffic continues to be repaired, the airport channel duty-free net interest rate will increase significantly compared to before the epidemic; the company's turnover level is leading the world in the industry. Affected by the global economy, the company's inventory turnover rate in 2023 is 1.88 Two/year, still in the recovery phase.

We have a different view from the market: liberalizing licenses is actually beneficial. Taking history as a guide, competition in the industry intensified after the liberalization of licenses in Korea. Subsequently, small duty-free companies were evicted, and leading duty-free companies recovered a high degree of market share (Lotte and Shilla's market share declined from 81% in 2012, and the market share of small-scale companies recovered to 65% in 2018 after being cleared), but the turnover of leading companies increased as the overall volume of the Korean duty-free industry expanded. Therefore, the liberalization of licenses only accelerated the clearance of small-scale enterprises. The combination of other policies determined vicious competition or unsustainable market share. Good leading company.

Profit forecasting, valuation and ratings. As a leader in the travel retail industry, the company will significantly benefit from the restoration of inbound and outbound passenger flow and the successive implementation of tax exemption policies in the city. At the same time, as the construction of the Hainan Free Trade Port progresses, the company's size advantage and card position advantage will greatly enhance the company's competitiveness. Net profit attributable to mother in 2024-2026 was 79/96/10.9 billion yuan, respectively, and the corresponding PE was 23/19/17x, respectively. It was covered for the first time, giving it a “holding” rating.

Risk warning: 1. Increased industry competition; 2. Uncertainty about customs clearance policies in Hainan; 3. Operation of new projects falls short of expectations; 4. Risk of exchange rate fluctuations.