Revenue fell slightly by 1% in the third quarter alone, and gross margin declined due to discount rates and channel combinations. Revenue for the first three quarters of 2023 was +7.3% year-on-year to 15.44 billion yuan, and net profit was 3.1 billion yuan, +214.1% year-on-year.

The company's gross profit margin was 33.1%, down 2.9 percentage points from the previous year, mainly because, on the one hand, the discount rate was poor, but based on efficient discount control, the discount rate improved quarter by quarter this year; on the other hand, the channel structure changed, and the share of franchise channels with lower gross margins increased.

The third quarter alone was affected by the decline in passenger flow and last year's high base. Performance fluctuated. Revenue was -1.0% year over year to 4.48 billion yuan; net profit was -93.8% year over year to 0.1 billion yuan. The large decline in net profit was mainly affected by the decline in gross margin, which fell 5.3 percentage points to 32.1% year on year; based on proper cost control, employee costs and rent expenses fell, and sales and management expenses fell 1.5 and 1.3 percentage points, respectively, and net interest rate fell by only 1.7 percentage points.

Inventories have declined markedly, turnover has increased, and cash levels have increased. Inventory management efficiency has improved based on prudent ordering strategies and an omnichannel hub plan for efficient inventory sharing with brand partners. The number of inventory turnover days for the third quarter of 2023 was 145 days, a decrease of 69 days over the previous year, and the inventory level fell 19% from the end of last year. Cash at the end of the period increased by 47.4% from the beginning of the year to 2.94 billion yuan, based on the increase in working capital turnover efficiency, the slowdown in opening stores, capital expenditure -2% year-on-year, and a decrease in debt levels.

The efficiency of the refined operation of stores continued to grow, and pan-micro stores grew strongly under the digital transformation. 1) Double-digit growth: 167 direct-run stores were closed in the current quarter, with a total of 537 to 3,556 direct-run stores closed in the first three quarters. Among them, the number of stores with a store area of more than 300 square meters increased to 21%, an increase of 2% over the end of 2022; the average store area increased by a high number of units over the previous year, and a double-digit year-on-year increase in floor efficiency; same-store sales increased 1.1% year-on-year in the first three quarters and -5.0% in the single third quarter. 2) Strong growth in pan-micro stores: The pan-micro store ecosystem is becoming increasingly important as a private traffic channel, mainly covering WeChat stores, Douyin live streaming, and shopping mall membership platforms. In the first three quarters, pan-micro stores grew strongly by 44% year-on-year, accounting for 13.1% of total revenue and 20.3% of offline direct marketing sales; of these, the single third quarter accounted for 23.3% of offline direct marketing sales, an increase of 2.8 percentage points over the previous month.

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

Investment advice: Be optimistic about the elasticity of short-term performance growth and the sustainability of medium- to long-term growth momentum. Looking ahead to the fourth quarter, with positive consumer trends, the strength of the company's omni-channel and pan-micro stores, and last year's low base, revenue growth is expected to resume; in the medium to long term, we are optimistic that the efficiency of existing stores will continue to improve under refined operations and digital transformation, and the potential to open stores in low-tier cities; at the same time, with positive management leverage and cost control and cost reduction benefits, it is expected that profit elasticity will continue to be unleashed. Based on fluctuations in performance in the third quarter and uncertainty about the recovery of consumption power in the fourth quarter, we lowered our profit forecast. We expect net profit for 2023-2025 to be 4.2/5.4/660 million yuan (previous value was 4.7/5.9/760 million), maintaining a reasonable valuation range of HK$0.77 to 0.88, corresponding to 7-8x PE in 2024, maintaining a “buy” rating.