In the face of major challenges in the catering industry, Haidilao's 1H24 turnover rate increased sharply to 4.2x year on year, and gross margin expanded by 1.7ppt year on year, reflecting Haidilao's strong brand strength and operational capabilities. However, we have the following five major concerns about Haidilao's future development prospects, which make us lack confidence in Haidilao's future performance growth momentum. Although the company's current valuation has returned to a low level, considering the continued weakness of the Chinese restaurant industry and the lack of certainty about the company's future growth, we continue to maintain Haidilao's “holding” rating. Based on 13x 2025 P/E (or 6.3x2025 EV/EBITDA), the target price was lowered to HK$13.2.

Concern 1: Main brand opening space: Haidilao opened a total of 11 new stores in the first half of the year, but 43 stores were closed at the same time, causing the total number of stores to drop by 32 to 1,343. Management said the company will accelerate store opening in 2H24 and aim to open new stores as a percentage of the total number of units in the total number of stores throughout the year (estimated 60-80). However, the company may continue to close inefficient stores at 2H24, and the number of store closures will decrease slightly compared to 1H24. We expect the number of Haidilao main brand stores to increase only slightly year-on-year in 2024, which is lower than the market's expectations at the beginning of the year. Since 2022, there has been no significant increase in the number of Haidilao stores as spending power and demand for food and beverage declined. Considering Haidilao's relatively high customer unit price level, we are increasingly concerned about the company's room for future store expansion and sinking.

Concern 2: Room for an increase in turnover rate: Based on Haidilao's strong brand power and pursuit of customer satisfaction, the company's 1H24 turnover rate increased by 0.9 to 4.2 times over the same period last year. However, entering 2H24, the turnover rate base began to rise (we estimate that the 2H23 turnover rate was more than 4 times), and the difficulty for the turnover rate to continue to expand over the same period last year increased. Management said the turnover rate remained the same in July compared to the previous year due to the influence of two fewer days of holidays. We believe that Haidilao will need to invest more in personnel and services if it is to continue to increase the turnover rate at the current relatively high level.

Concern 3: There is room for profit margin improvement: With the turnover rate increasing sharply year over year and gross margin expanding significantly year over year, the company's 1H24 core operating profit only increased 13% year over year (slightly slower than 14% revenue growth), and the core operating profit margin declined slightly year over year. The main reason is that the company's 1H24 raised the level of manual salary while supplementing store employees, increasing the ratio of labor costs to revenue by 2.8ppt year-on-year. We understand that the company wants to improve the quality of service and increase the turnover rate by increasing the number of employees in the store and strengthening employee incentives. However, after entering 2H24, there is limited room to increase the turnover rate. Operating leverage helps to reduce, and profit margins are likely to face greater pressure than in the first half of the year.

Concern 4: Multi-brand strategy: The company proposed a red pomegranate plan in the first half of the year with the aim of expanding new food categories and brands and creating a new growth curve. In fact, Haidilao actively launched multi-brand operations long before the pandemic, and tried different food segments other than hot pot, but the results were not ideal. Considering that the current demand in the catering industry is weak and the competitive environment is more intense than before the pandemic, we believe that Haidilao's multi-brand strategy may bring some room for imagination to the market, but the current visibility is still low.

Concern 5: Franchise model: The company introduced a franchise model and opened the first Haidilao franchise store in 1H24. The management said that the partnership with Haidilao was widely welcomed. The company hopes to accelerate the pace of franchise store expansion in the second half of the year, expand coverage through the franchise model, and achieve store expansion and decline. As far as we know, Haidilao's selection requirements for franchisees are very high (limited to institutions or enterprises with sufficient financial strength and social resources, etc.). We are skeptical about the rate at which Haidilao franchise stores are expanding.

Investment risks: Increased competition in the industry; decline in Haidilao brand strength; sharp rise in labor costs.