Market concerns mainly include 1) short-term pressure on profits; 2) decline in main account GMV data; 3) the stability of major anchors and the company's management strategy are still in the adjustment period. We believe the company's profit margins may have bottomed out in the 3rd quarter of FY2024 (ending February 29, 2024). The third quarter of fiscal year 2024 was a strategic adjustment phase for the company, increasing the promotion of self-operated products, which led to a decline in the gross margin of self-operated products. After the Spring Festival, operations gradually returned to a normal pace, and live broadcasts were promoted more actively. It is expected that the company's profitability in the fourth quarter will improve compared to the third quarter. However, considering that self-operated products are still aimed at scale growth in the short term, there is still uncertainty about the level of investment.

Main account traffic growth is facing challenges, and part of GMV's size is being diverted from shelves and other channels. After the “Little Essay” incident, the Dongfang Selection main account experienced a brief decline in the number of fans. Currently, it has stabilized at the level of 30 million, but it does reflect a situation where new traffic growth is under pressure, and the company's long-term expansion and development is facing challenges. After the launch of the Dongfang Selection main account live broadcast room (excluding shelf sales), GMV dropped to 2-3 billion yuan (RMB, same below) in February-March, and is currently stable month-on-month. On the one hand, the decline in main account data reflects the pressure on traffic growth. On the other hand, it also reflects the impact of being diverted by Matrix accounts, etc., and the average daily GMV is estimated to be around 10 million yuan (including shelf sales amount). Since late March 2024, Oriental Selection has resumed a special outdoor live broadcast, which is roughly in line with the GMV scale of the special event before the “Little Essay” incident. We have observed that during the special event, incentive activities such as distributing lucky bags in the live broadcast room promote self-operated products. Although they will expand customer acquisition channels for self-operated products in the long term, they will affect the company's profit margin in the short term.

Together with Hui, we have entered a stable operation phase, contributing to profit growth. We believe that Huitong's live broadcast room is expected to maintain an average daily GMV of 15 to 20 million yuan and a monthly GMV of 5-6 billion yuan. Subsequent cultural sessions will continue to export the live broadcast room tone. Through the brand/location special, it is expected to push the GMV of a single live broadcast to break 100 million, maintain the stable operation of the live broadcast room, and contribute to the company's profit growth. The management previously announced that there will be no simple profit sharing with Dong Yuhui. Despite rising personnel costs, the company's profit structure is still superior to other MCN's.

The target price is HK$13.40, the initial payment is neutral. We expect the company's revenue to increase 45%/13% year over year to 6.6 billion yuan/7.4 billion yuan in fiscal year 2024/2025; adjusted net profit is 690 million yuan/8.4 billion yuan, a decrease of 37%/23% compared to FY2023 1.1 billion yuan. We believe that after developing independently with Hui, Dongfang's selection strategy focused on self-operated product construction, while the increase in main account traffic and Taobao channel contributions remain to be seen, and new businesses such as instant retail and overseas sales are still in their early stages. Based on the valuation range of Chinese consumer brands, MCN institutions and e-commerce platforms, we believe that the company's reasonable price-earnings ratio is 16 times, based on adjusted net profit of RMB 840 million for FY2025, and a valuation of HK$14.5 billion, corresponding to a target price of HK$13.40.

We are optimistic about its proprietary product strategy, and at the same time, it has better profit margins and business ceilings compared to other MCN organizations, so we enjoy a valuation premium. However, considering the short-term profit margin trend, there is still uncertainty and the recent business strategy management adjustment period. The current price already reflects the short-term business growth potential, and the initial neutral rating is given.