Investment thesis:
Shangpin was established as an interior design software company in 2004. The strong designing expertise enabled it to become the first in industry to launch the idea of whole-house customized furniture, and provided Shangpin with a higher sales per order than peers. On the back of its large customer database,Shangpin is able to adjust strategies according to customer needs and launcheda series of innovations including the shopping mall store, whole-house fitout,and free design and measurement service, which allows it to attract the growing middle-class and become a tier-1 customized furniture maker.
Whole-house fitout becomes an industry mega trend. 1) ToC. Whole-house customized furniture increases the usage of space, uniforms design style and brings one-stop shopping experience for customers. 2) Industry. As the competition intensifies,furniture makers are striving to diversify channels and expand product range toboost sales.
We believe Shangpin will outperform given its unique retail-based operation strategy and strong competitive edges in designing ability.
Innovative channels. Shangpin was the first to develop shopping mall channel, whole-house interior fitout channel and online-to-offline channel. Shopping mall stores have higher traffic than traditional furniture malls. This enabled it to liftbrand recognition and avoid direct competition with peers. The company alsolaunched whole-house interior fitout service, empowering interior companies with free IT systems, interior design software, supply chain management and cloud computing platforms, and providing cheaper products and whole-package services. This may become an important channel in the future. Meanwhile, it attracted a large number of followers on various social network platforms,which transferred to offline traffic in its brick-and-mortar stores.
Advantage in design gives high conversion rate. The firm’s artificial intelligence-enabled cloud design platform significantly improves the designquality. Together with many designers in store, Shangpin is able to provide interior designs faster and better, avoiding potential customer loss during the design process. In addition, it expanded its product range from cabinetry and furniture to building materials, which completes the whole-house fitout package. This will also double the sales per order for distributors.
High same store sales and asset turnover. While innovative channels and marketing brings more customers, Shangpin’s expertise in design results in high customer-to-order conversion rate, and its comprehensive product portfolio boosts sales per order. These together lead to strong same store sales andasset turnover.
Initiate with Outperform. Shangpin’s unique information technology- and retail-based mindset differentiates it from peers, and brings it the ability to adjust strategies, products and services according to customer needs. We therefore seea higher revenue ceiling for the firm compared with traditional furnituremakers. We forecast EPS of Rmb2.87 in 19E (+19.3% YoY), Rmb3.43 in 20E (+19.6%YoY), and Rmb4.03 in 21E (+17.7% YoY). The stock is trading at 25x 19E PE, 21x20E PE and 18x 21E PE. Our target price of Rmb92.47 implies 32x 19E PE. With 28.5% upside, considering the potential downward effect of mismanagement of franchise channel, we initiate coverage ofthe stock with an Outperform rating.
Investment Thesis
Earningsforecasts and valuation
Initiate with Outperform. Shangpin’s unique information technology- and retail-based mindset differentiates it from peers, and brings it the ability to adjust strategies, products and services according to customer needs and innovate business models. We therefore see a higher revenue ceiling for the firm compared with traditional furniture makers. We forecast EPS of Rmb2.87 in 19E (+19.3%YoY), Rmb3.43 in 20E (+19.6% YoY), and Rmb4.03 in 21E (+17.7% YoY). The stock is trading at 25x 19E PE, 21x 20E PE and 18x 21E PE. Our target price of Rmb92.47 implies 32x 19E PE. With 28.5% upside, considering the potential downward effect of mismanagement of franchise channel, we initiate coverage of the stock with an Outperform rating.
Key assumptions
Revenue:1) Self-owned stores: we expect the number of wholly-owned stores to decrease by six stores in 19E, two stores in 20E and another one store in 21E, with a same store sales(SSS) growth of -5% YoY in 19E, 0% YoY in 20E and 21E. 2)Franchise stores: we expect franchise store network to grow rapidly in 19-21E.We anticipate an increase of 360 stores in 19E, 320 stores in 20E and 300stores in 21E. Due to the competition, we forecast same store sales (SSS)growth of -10% YoY in 19E, 2% YoY in 20E and 2% YoY in 21E.
Profitability remains strong. We believe the increasing proportion of franchise stores will push up net margin, which will be offset by whole-house interior fitout business that still in the infant stage. We anticipate a steady growth in net profit margin (+57bps YoY in 19E, +51bps YoY in 20E and +45bps YoY in 21E) due to the fall in operating expenses as a percentage of revenue.
How we differ from consensus
1)The market believes that customized cabinetry are entering a phase of tough competition. We believe Shangpin, with its strong designing capability, diverse distribution channels and comprehensive product collection, can continue to outperform peers in terms of store traffic, customer conversion and sales percustomer.
2)The market believes that sluggish growth in new home market will have a significant downside impact on the home furnishings industry. However, we believe the shrinking demand will be offset by growing needs for existing homerenovation. Shangpin’s current customer mix contains c.20% of renovation customers. Its strong presence in large shopping malls and unique advantage indesign will allow it to capture customers who need home renovation.
Catalysts
Whole-house interior fitout division performs better than expected
Risks
Tougher-than-expected operating problems in franchise channels; Weaker-than-expected housing market
1.Customized home furnishing & lifestyle2. Whole house product package with quality design2.1 Newfurnishing demand—more personalized and practical2.2Whole-house customized furnishing 2.02.3 Designas the core to monetize customer visits2.4 Newretail store format: Collection stores3.Diversified channels3.1Intensified competition and decentralized traffic3.2 Capturingrenovation customers by Shopping mall stores3.3Accelerating channel expansion through franchise stores3.4 Newchannel: whole-house interior fitout4. Unique retail thinking4.1 Createcustomer profiles to outcompete peers4.2 O2Omarketing accurately targets the young generation5. Earnings forecasts and valuation6. Appendix
1.Customized home furnishing & lifestyle
Formed in 2004, Guangzhou Shangpin Home Collection (Shangpin) is one of the top three whole-house customized furniture manufacturers in China. Itscore product categories include cabinetry and other furniture, which generated 75.5% and 16.8% of 18A revenue, respectively. It adopts a dual-brand strategy, positioned to suit the middle-class to high-end customer groups. In addition to furniture sales, the company also directs consumers to offline distributors through its online channels, which enables it to charge a small amount of fixed fee and commission from final product sales. Online-to-offline traffic direction business contributed c.2.3% of 18A revenue.
IKEA-like ideas and whole-house fitout with strong price performance. Shangpin offers a wide variety of furniture products including cabinetry (such as wardrobe, kitchencabinets, decorative cabinets, shoe cabinets, TV stands, tatamis, children’sbed cabinets, etc.), other home furniture (such as sofas, mattresses, beds,curtains, tables and chairs, etc.) and building materials (such as wooden floors,tiles and doors) which are priced more competitively compared with peers. On the back of its high-quality design software and rich designer resources,Shangpin provides tailor-made home design solutions to customers. The design styles range from modern Chinese, traditional Chinese, European, Nordic,American Pastoral, modern Simplism, etc. We see the company’s whole-house customized furniture design concept and cost-effective pricing strategy as similar to that of IKEA’s.
We divide Shangpin’s development into three stages.
1) From software to furniture manufacturing.Shangpin, formerly known as Yuanfang Software, was founded by Li Lianzhu, Peng Jinxiong and Zhou Shuyi who all graduated from the Mechanical Manufacturing School of from South China University of Technology. They usedtheir expertise to build the home design software, Yuanfang which provided countless sets of design solutions to interior decoration companies as well as floor,tile and cabinetry manufacturers. They also established a home decoration platform (72home.com) and accumulated experience in online platform operation.In 2003-2004, the firm entered the cabinetry manufacturing business to take advantage of the fast-growing demand for customized furniture, forming twobrands, namely “Shangpin Kitchen Cabinets” and “Wayes Wardrobes”. In 2006, the company combined the two segments and created two new whole-house customized furniture brands “Shangpin Home Collection” and “Wayes Whole-house Customization”. At the same time, Shangpin leveraged its advantage in software development and information technologies, and introduced an order and production management system, which enabled it to build up a customer data center and connected the whole production process from design to manufacturing. The order and production management system then became the cornerstone for the whole business model.
2) “C2B+O2O”business model. Following 72home.com, the company established another home decoration platform Homekoo.com, successfully connecting designers, constructors, decoration companies and end-consumers. In 2009,Yuanfang Software, Foshan Weishang (Shangpin’s manufacturing subsidiary) and Homekoo.com were merged under one parent company, Guangzhou Shangpin Home Collection. Different from traditional business-to-consumer (B2C) model, in a consumer-to-business(C2B) model, customers can participate in the furniture designing stage by accessing company and product information online first and visiting a brick-and-mortardirect-sale or franchised store later. Shangpin also offers free whole-house design and door-to-door house measurement service. As the order and productionmanagement system evolves, every confirmed design is automatically formed into sales order and proceeded with manufacturing process instantly. Thanks to the substantial customer data and wide furniture selection from Yuanfang, the company is able to offer unique designs suiting different customer needs, and quickly gained a foothold in home furnishing industry.
3) Channel expansion and business model evolution. After its listing in March 2017, Shangpin adjusted its strategy and focused more on revenue growth and market share by aggressive channel expansion and large-scale online and offline marketing. In 2018, the number of stores increased by 559 (with820 new stores opened and 261 closed), and by 161 in 1H19. In early 2019,Shangpin launched a new concept of whole-house customized furnishing 2.0,offering building materials (such as backdrop walls, flooring, tiles and doors)to match with its furniture. This completed its furnishing product mix and enabled it to provide one-stop furnishing solutions to meet the needs of middle-class customers. In addition to traditional distribution channels, thefirm launched a whole-house interior fit out business line branded “HOMEKOOCloud” at the end of 2017, which empowers and collaborates with medium- to small-sized interior companies, to capture front-end customer flow.
Rapid top-line and bottom-line growth. Benefiting from macroeconomic growthand consumption upgrades, the whole-home customized furniture industry has undergone rapid expansion in the past few years. In the meantime, Shangpin branched out hundreds of new stores, operating a total of 2,362 stores (including 2,269 franchised stores and 94 self-operated stores) as of end-1H19. The company reported 18A revenue of Rmb6.65bn (+24.8% YoY, representing a 5-year Cagr of 41.4%), and net profit of Rmb477.08m (+25.5% YoY, with a 5-year Cagr of 32.5%), significantly outpacing its peers. Despite the downturn of the property market, Shangpin maintained strong momentum in 9M19, generating revenue of Rmb5.06bn (+9.0% YoY), net profit of Rmb335.17m (+14.5% YoY) and a net profit before extraordinary items of Rmb285.02m (+50.6% YoY).
Factory coverage gradually increase. Before IPO, Shangpin only has one factory in Foshan with full capacity utilization, utilization rate over 90%. With IPO fund raised, Shangpin boosted its capacity expansions in Foshan and Wuxi, which would cover the demand ofsouth and east area of China. The expansion of Foshan factory has completed and Wuxi factory recently commenced operation. With the increase in factory coverage, the delivery time and cost will be reduced.
2. Whole house productpackage with quality design
The new generation of home buyers has a strong preference for one-stop, convenient shopping experience. Backed by excellent retail operations, Shangpin creates productsand business models that precisely match customer needs, providing one-stop services based on its whole house design capability to meet consumer's needs for home renovation.
2.1 New furnishing demand—more personalized and practical
According to Sohu’s survey, younger generations are becoming the main home buyers in China, and about 68% of them belong to the new middle class born in 1980s and 1990s. Compared with the older generation, younger ones pay more attention to personalization, practicality,aesthetics, convenience and healthiness with lower sensitivity to price, which makes whole-house customized furniture rise in popularity:
1)Practicality: Under the background of high housing prices, home owners have stronger demand for efficient space utilization. With the rapid rise in housing prices inrecent years, buyers are unable to afford large-sized houses, and real estate developers mostly build small-sized houses, with room area of less than 90m2 accounting for 34% of the total. Compared to finished cabinets, whole house custom cabinets fit better with the house type. The company's tailor-made storage space with the efficient use of corners, gaps, and high and low space create a cost-effective, comfortable and practical living environment.
2)Aesthetics and convenience: Designers select the cabinets and furniture through whole-house customized furniture services with unified style, providing one-stop home furnishing solutions for consumers. With a view to the sales model of the global home furnishing leader IKEA,we find that displaying products in a real home style can stimulate furnishing consumption demand more than displaying each product solely. Meanwhile, consumers generally buy home furnishing products in addition to cabinets in a bid to pursue a sense of home integration. Through ample product mix, whole housecustom designers ensure the beautiful and unified style of the whole house, andsolve the troubles of products matching. Moreover, one-stop purchase is more worry-free and labor-saving, and more suitable for the consumption habits ofthe younger generation.
3)Personalization: All tailored made, the style and color can be changed according to consumers’ preference. After designers take the measurements and puts forward a sample design, customers can make modifications to the size,color, function, materials and any other aspects according to their preference.After the design is determined, the order will enter the manufacturing processwhere the factory works on a just-in-time basis. When the products are finished and delivered to distributors, they will arrange a time with customers to complete the installation. The customized cabinetry solves the problems of fixed size and style of ready-to-use cabinets, and fully satisfies consumers’ personalized needs.
4)Healthiness: Most of the whole-house customized furniture are branded, ensuring high quality and healthiness. In the past when hand-made cabinets prevailed, the materials used and safety levels were largely unknown. Nowadays, people pay more attention to health and quality, and are willing to pay extra money for better products. The whole-house customized furniture companies typically use wooden boards graded E1 or higher,and provide 5-10 years of warranty service, thus making consumers feel more assured.
2.2 Whole-house customized furnishing 2.0
Given strong design capabilities, Shangpin has transformed from a single products supplier to a whole-house customized furniture and interior fitout solutions provider.Most of the customized furniture companies start from providing single products such as wardrobes and kitchen cabinets, before diversifying product offerings and brands to provide whole-house customized furniture services. Unlike peers, Shangpin has leveraged its excellent software development and design capabilities to deliver whole-house customized furniture solutions to customers since 2006. In 2H17,the company started to promote auxiliary home furniture products (like sofas,beds, mattresses, tables, and chairs). The company includes a full range of its products in 3D design, and creates a real living scene through store display to motivate consumers to purchase auxiliary furniture. In 2019, the company took the lead in launching the concept of “whole-house customized furnishing 2.0”,which packages building materials, cabinets, auxiliary furniture products together.The company also expands its product lines to decoration items (such as curtains,lighting and paintings) and home appliances. With more diversified product offerings, designers can improve the overall display effect to fully meetconsumers' needs of home furnishing in one package, which will further increase the spending per customer and revenue per store.
“Whole-house customized furnishing 2.0” create a one-stop home furniture shopping experience, and the large pool of SKU increases sales per order. The company's accessory home furniture products currently mainly include more than 30,000 SKUs including sofas,coffee tables, tables and chairs, beds, mattresses, kitchen washing utensils,kitchen appliances, wooden doors, curtains, and background walls, mainly based on the OEM and consignment models. The price of branded products sold by the company as an agency is lower than the retail price in the market (but cannotbe purchased separately), prompting consumers to purchase supporting home furniture alongside cabinets. For distributors, they only needs a small store area to display the building material package, which can help them to capture the purchase potential of each customer. The company also integrates whole product lines into promotional packages. Starting 2018, Shangpin launches the " Rmb518/㎡" whole-house customized furnishing package, in which each item has several styles for selection, and a consumer only needs to spend c.Rmb47,000 (corresponding to 80-100m2 rooms) to buy all the furniture except home appliances. The package has played a pivotal role in attracting customers and increasing sales per order, while contributing additional profits for the company. In 2018, Shangpin’s accessory homefurniture business posted revenue of Rmb1.1bn (+42.5% YoY). Following the improvement in supply chain and expanding SKUs, we expect the segment revenue to continue to climb in the coming years.
2.3 Design as the core to monetize customer visits
Design is the core of sales conversion in customized furniture industry. Shangpin, equipped with its own powerful software design capability, provides customers with free door-to-door measurement service. Whole-house customized furniture tests the design ability of the store salesperson/designer, because in addition to the complexity of home size, functional space allocation, storage space, overall visual effects and user experience are also in consideration. Shangpin is far superior to competitors in terms of software, no. of designers in stores, and implementation:
①Softwarestrength: The software gene provides Shangpin with strong technical support. The company started asYuanfang software design company, its software covers decoration, civilfurniture, cabinet and wardrobe, ceramic tile, bathroom, front-end sales and back-end production. Processes from designàplace orderàback-end productionàlogistics and transportation are completed on the order management system and tracked in real time, which plays a strong supporting role for front-end sales and huge SKU system. In addition, the company is the originator of the design software. Over 20 years, it has collected thousands of sets of design plans, floor plans and furniture category materials on the back end. 4K high-definition renderings can be completed within 10 seconds through the new light-speed rendering cloud, which draws the speed increased by 20-100 times. This technology is especially suitable fordesigners to communicate face-to-face with customers, it can quickly adjust the program and present the whole house design renderings faster than peers to improve the customer conversion rate and reduce the loss rate.
②Store designer: design-oriented business mode. It employs a large number of designers or graduates from design major. O-store has an average of about 100 designers, and5-10 in regular stores. The designer resources are far more than competing products (about 2-3 regular stores). Compared with traditional shopping guides,designers can better understand the needs of consumers for home decoration, and they can use Yuanfang software to provide simple design samples in the store,which can achieve better communication with customers and make it easier to geta door-to-door measurement opportunity.
③Implementation: The company has abundant designer resources and attaches great importance to design. All store designers will actively use Yuanfang software in the service processes. The company's first-line designers are closely connected with R&D personnel and can upgrade the software to continue to follow the market demand if encountering any design problems or changes in market trend. In addition, other customized furniture companies mostly purchase design software from third party or adopt self-developed software, and often encounter problems such as unskilled manipulation, slowspeed of 3D renderings, etc., which make designers focus on paper drawing in actual operation. In this way, it is difficult to quickly visualize the frame diagram for other companies, and the flow conversion rate will be less than Shangpin.
AI Cloud Design--Invisible helperbehind the designers
With the rise of the concept of Whole-house customized furniture and interior fitout,designers have become a scarce resource. In recent years, the company has rapidly invested in promotion and channel expansion. The ability of the designers in the franchise stores is unsure, which has directly led to problems such as measuring errors, improper design, and lost orders.
AI Cloud Design empowers the vast no. of designers. In the middle of 2018, the company launched the “AI Cloud Design” system internally. After the designer uploaded the plan to the cloud platform, the system will automatically score according to the furniture, accessories, materials, lighting, color matching, etc. If the score is unqualified, the system will partially modify and optimize the designto generate a Plan B design, including one-button light filling, one-button patching and etc., which can significantly improve the quality of plans oflow-end designers. When the system was first introduced, it required a lot ofmanual modification, and one single design took about 15 minutes to modify.Although there are still a small number of manually modified parts, the proportion has been significantly reduced, for example, the quality of automatic lighting rendering is close to that of a "level 4 designer" of the company.The launch of the cloud design system has significantly improved the transaction rate, and greatly reduced the phenomenon of losing orders due tothe design, in particular, it has played a significant role in the relatively deep channel market such as the 4th- and 5th-tier cities,which reducing the pressure on franchisees to recruit qualified designers. Asthe system continues to optimize in the future, it will gradually improve the level of automation, and it is expected to introduce an optimization system that only requires little labour.
“Design Island” platform, atraining and incentive system for designers
An innovative designer interactive ecosystem – “Design Island” helps to continuously strengthen the training and management of designers and attract talent. Given a large number of new designers in the market, each customized furniture enterprise has been troubledby management problems and low motivation to some extent. Shangpin takes advantage of its internet genes to create a “Design Island” online community with game field management thinking. It has assembled more than 10,000 “designheroes” of different levels nationwide, using point exchange, friendly competitions,and interest tribes to stimulate motivation and creativity of young designers.Designers can earn points by uploading their designs, among other measures.Points can be exchanged for gifts (including smartphones, airline tickets,travel and other prizes). The company also assigns orders and determines commission rates based on the level of the designers. High-level designers can receive large orders and higher commission rates (1.5%, 2.5%, and 3.5%),resulting in substantial bonuses. In addition, excellent designers can also enjoy the opportunity to learn and work with well-known foreign interior designers. We believe the “Design Island” platform has effectively prompted designers to enhance their designing capabilities and share solutions, ensuringthe company to attract and retain outstanding design talent and sharpen the competitive edge of its design services.
2.4 New retail store format: Collection stores
Collectionstores (C-stores) are flagship stores that provide furniture customization and entertainment services.The company opened a C-store with an area of over 3,000sqm in Shanghai in April2018, the first step in the company's exploration of new retail formats. Inaddition to displaying customized home products, the store also combines different formats including coffee (12Hours Coffee) and floral (Tai Di)shops, hand work and book bars, children’s entertainment facilities, and self-service retail counters, in order to attract customers to the store,prolong their stay, increase the re-visit rate and customer loyalty, and createa new experiential consumption space for customers. Following the success of the Shanghai C-store, the company immediately opened C-stores in Beijing andGuangzhou, covering an area of 5,000sqm. In the future, the company may also transformits O-stores to C-stores, and integrate low-frequency customized home productswith various medium- and high-frequency products in a bid to explore new retailmodes.We believe that in the future, China's furniture retail market will be characterized by greater convenience, higher purchase frequency and more diversified offerings,and Shangpin’s internet-based innovative ability will enable it to continue to pioneer in the industry. Forreference, overseas mature players such as IKEA in Europe, NITORI(9843:JP) inJapan, and The Home Depot (HD:US) in the US have survived the impact of new business formats such as e-commerce, on the back of inexpensive yet high-quality products, broad product offerings (one-stop experience), impressive offlinestore experience (dining area, children's entertainment area, etc.) and fast logistic distribution, so that these brands are perceived as the embodiment of"a better life" by consumers. Shangpin has made forays into the above-mentioned fields, partnering with brands in other industries to create an exceptionally comfortable lifestyle for consumers and turning shopping into a kind of enjoyment. Meanwhile, the company continues to keep up with the latest industrial trends.
3. Diversified channels
Diversified channels. As furniture consumption scenes diversified in recent years, we noted the emergence of a slew of new channels, including furnished homes,interior design companies, whole-house interior fitout companies, community marketing and E-commerce platforms, which diverted traffic from traditional furniture stores.
Customer mix shifted. The sluggish real estate market has significantly impacted the home furnishing market. While the number of new-home owners is decreasing, the demand for house refurbishment and renovation is increasing. Meeting demand from these customers has become a challenge for furniture companies.
We believe Shangpin is the only furniture supplier that operates under an innovative retail business model and adopts forward-looking strategies in terms of channel expansion and customer attracting, which enabled it to deliver faster-than-industry growth in the past few years.
3.1 Intensified competition and decentralized traffic
Rapid expansion in supply. The whole-house customized furniture industry underwent rapid growth before 2017. The capacity utilizationrate of major players reached 90-100%. During 2017-2018, a total of seven companies launched IPOs, with the funds raised helping them to expand capacity and channels. We estimate the total capacity of these companies would double from 2.28m units to 4.54m units after the completion of the capacity expansion projects.
Channels:store expansion accelerated since 2017. Thereare eight listed companies in the whole-house customized furniture industry. Thetop three players, Oppein Home Group (603833:CH-O-PF), Suofeiya Home Collection(002572:CH-BUY) and Shangpin opened a net of 2,621 stores in 2017 and 1,479 storesin 2018. As the growth slows down, store network expansion has decelerated since2018.
Concerns in the short-term. The surge in supply resulted in decentralized visitor traffic and slower same store sales (SSS) growth.In addition to opening stores in traditional furniture malls such as RedStar Macalline Group (002572:CH-O-PF, 1528:HK-N-R) and Real Home, furniture companies are actively expanding emerging channels such as online platforms, interior design companies, designer studios, engineering channel (furnished rooms fordevelopers) and various new retail channels (including community stores,supermarkets, shopping malls, etc.). With intensified competition, same storesales growth has decelerated since 2017.
3.2 Capturing renovation customers by Shopping mall storesShangpin operates four types of stores, namely, shopping mall stores, O2Ostores (which maily open in office buildings), collection stores (C stores) andother stores.Its self-operated stores, which inlcude shopping mall stores,O2O stores and C stores, generated c.38% of 18A revenue, while franchise stores,inlcuding part of the shopping mall stores and stores in traditional furnituremalls, accounted for c.54% of 18A sales.
Innovation in distribution channels.As home furnishings products are large in size and require sufficient space for display, most companies openstores at furniture malls with lower rents. However, with the shift in consumption trends and decentralized traffic, traditional stores are facing pressure in terms of traffic and sales. Shangpin was the first whole-house customized furniture maker that established a shopping mall retail model. As of end-2018, shopping mall stores accounted for c.46% of the firm’s total store network, and the majority of its 94 self-operated stores are located in shopping malls. In first- and second-tier cities, approximately 70% stores are shopping mall stores.
Large investment, prosperous returns.Opening a store in a shopping center means that the company and the franchisee need to bear great rent pressure in the early stage. The monthly rent of stores at shopping centres ranges between Rmb500-1,000/sqm, while that of traditional stores is only Rmb30-80/sqm. The sales-to-rental ratio could be up to 8x for shopping mall stores. Meanwhile, it is more difficult to obtain a good location in shopping centres compared with traditional furniture malls, and the operating costs are several times higher, which imposes pressure on the distributor’s managementability.
However, we believe shopping mall stores enjoy the following three advangtages, which creates a higher revenue ceiling than other types of stores.
1) Frequent customer contact to capture existing homeowners and renovation customers. Most traditional furniture department stores(e.g. Red Star Macalline and Real Home) are far away from city centres, making it very time-consuming to visit, especially for customers who only need partial renovation or redecoration of their homes. Before the existence of shopping mall furniture stores, they would choose not to renovate until purchasing a new home. The emergence of whole-house customized furniture stores in shopping malls has significantly spurred the need for home renovation and decoration. This can be proved by Shangpin’s customer mix. Renovation customers constituted for 18% of Shangpin’s total customer base in 2018 (compared with only 14% for 1H17). Particularly, considering the slowdown new home sales, the demand for renovation of existing houses will keep increaing, which will further push up so the proportion of renovationcustomers. This also helps furniture makers hedge the risks from property market controls in China.
2) Avoid direct competition with peers.In traditional furniture department stores,there are many different brands demonstrated on the same floor. Distributors and furniture companies launch various promotion strategies to attract customers. Shangpin’s shopping mall stores enables it to stand out from rivals with less fierce competition.
3) Enhance brand awareness.As most shopping malls are located in the city centre with high population density and strong traffic. They also open longer compared with traditional furniture department stores (which normally open from 10:00 to17:00). As it is generally more difficult for furniture makers and distributors to enter shopping mall, once they succeed, the store can create a strong brand image and instill an impression of reliability and popularity to consumers.
Thanks to these advantages, shopping mall stores provide Shangpin with far higher SSS than peers.In 2017, the average SSS of Shangpin’s shopping mall stores reached c.Rmb6.6m, higher than the other stores of the company (c.Rmb3.8m)and SSS of competitors (Rmb2-3m). As Shangpin’s newly-opened stores gradually mature, we see further room for its SSS growth.
3.3 Accelerating channel expansion through franchise stores
Opening franchise stores in cities which have only self-operated stores. Self-operated stores contributed 38% of total 18A sales. As of end-1H19,the company directly operated 94 stores in tier-1 cities and provincial capitals (such as Guangzhou, Beijing, Shanghai, Nanjing, Wuhan, Foshan,Chengdu, andXiamen), and 137 newly-opened franchise stores in these cities. The majority of the franchise stores are opened and operated by former employees coming from directly-operated stores, and most of them are located far away from the directly-operated stores in downtown areas.
We believe allowing franchising in these cities can bring the following advantages:
1) Explore the big growth potential in tier-1 cities.Consumers intier-1 cities typically have strong purchasing power and large market size.Shangpin used to solely rely on the direct operation model, under which expansion was slow annd costly and it was difficult to reach customers from remote regions. Franchising can help the company quickly increase its coverage and explore the big demand growth potential in large cities.
2) Easier to manage.The headquarters provide all the post-sales services to customers, including delivery, installation and maintenance, and share citywide advertising coverage, easing burdens from franchisees’ shoulder.Meanwhile, the operating cost is lower than franchise stores in other cities.As such, new franchise stores in tier-1 cities are much easier to manage, to operate and to achieve breakeven.
3) Operation by former employees.Backed by their working experience in Shangpin,former employees are more familiar with the company’s systems and marketing strategies and thus enjoy better customer acquisition and product design capabilities than ordinary external franchisers.
3.4 New channel: whole-house interior fitout
Closely in-line with new fitout trend.At present, consumers prefer one-stop shopping experience and consistent home interior design style. As a result, a new interior model - whole house interior fitout, gradually evolved to capture traditional visitors in furniture stores. Shangpin closely followed this trend and innovatively launched HOMEKOO Cloud (a membership mode, similar to franchising) and a self-operated whole house interior fitout business in the end of 2017. It provides a full range of services consisting of interior design, cabinetry, furniture and building materials. This matches Shangpin’s concept of ‘design and order your lifestyle’, providing whole-package services to meet customers’ needs and capture scattered visitor flow.
1) HOMEKOO Cloud:S2B2C business model. Due to recent real estate policies, about 15% ofnew homes are furnished, which impose great pressure on building materials distributors and interior companies. Such distributors and companies generally have local decoration teams and building materials sources but are unable to provide customized cabinetry and matching furniture, in addition to weak bargaining power towards building materials wholesalers, though they are longing to provide whole house interior fitout services. Through Shangpin’s strength in software technology and centralized purchasing, it empowers small-to medium-sized interior companies with free IT systems, interior design software, supply chain management and cloud computing, enabling them to provide whole-package services (incl. customized cabinetry and furniture) to end customers with cheaper products and higher efficiency.
Software.Shangpin offers four software systems for free, including 3D interior design software, architecture-level BIM virtual fitting system, supply chainmanagement system, and central site management system. The design software isable to calculate the quantity of all materials needed and directly generate aprice budget and construction instructions as soon as the designer finishes the interior design. It digitizes the whole construction process, solving thefrequent confusion of pricing and difficulties in site management for both customers and interior companies.
Whole-house customized furniture fitout.With Shangpin’s full colletion of furniture (such as kitchen cabinets, wardrobes, cupboards,sofas, mattresses, tables, chairs and etc.), it solves a common problem for interior companies which do not have such wide range of products. It helps those companies to grow into whole house interior fitout companies and raise their sales/transaction per customer from Rmb100k to Rmb200-300k.
Centralized purchasing.As an interior company becomes a member of HOMEKOO Cloud, it can buy all the materials and inventories from HOMEKOO Cloudplatform. As the number of members grows, Shangpin can purchase products in bigger bulks and enjoy more favourable prices than individual small interior companies. With the help of supply chain management as well as fexible distribution and logistics services, it also reduces the inventory levels and delivery time for members.
HOMEKOO members only need to provide interior design, installation and payment reception.All the remaining procedures are done by HOMEKOO Cloud, which can help minimise the difficulties in sales, design, site management, supply chain management, and purchasing amongst others. Shangpin also encourages its membersto open standardized display stores to showcase cabinetry products, furnitureand building materials, as well as tier-1 brands in each category, such as TATA in doors, Dongpeng in tiles, Powerdekorin wooden floor, and NipponPaint inpaint. The display stores enable customers to buy everything they need in one shop and persue their desired living area and lifestyle through whole house customerized furniture.
Capturing another channel to acquire customers.A certain percentage of customers visiting HOMEKOO member stores also buy Shangpin’scabinetry and furniture. So HOMEKOO Cloud not only helps thousands of interior companies, but also becomes an important channel for Shangpin to sell whole-house customized furniture. As of end-1H19, the number of HOMEKOO Cloud members has grown to 1,663, which is likely to grow into a key channel for Shangpin to reach end customers in the future.
2) Self-operated whole house interior fitout business. In order to familiarize the interior fitout process and understand customers’ needs, Shangpin started its own interior fitout business in Guangzhou, Foshan, and Chengdu, providing all the services and products needed for whole house fitout. Based on Shangpin’s experience, c.20% of customized furniture customers also have the demand for interior fitout. Despite largeCapex and difficultilty to make a profit in its early stage, we believe the operation of its own whole house fitout business can help Shangpin to better identify the problems facing HOMEKOO members and instantaneously work on thesolutions and upgrade software systems. This will help HOMEKOO Cloud to become more than just a supply chain and purchasing platform, since it aims to solve the inefficiencies and problems in the interior industry through a more systematic way.
Transparent pricing scheme. With allthe materials, brands, prices, furniture, and cabinets listed in the budget list, consumers can pick, upgrade and customize the product mix and design as they desire. Currently, the average spending per customer is c.Rmb170-200k(including building materials, furniture, customized cabinetry and auxiliary products). Shangpin has built a two-storey, 5000㎡ flagship display store in Guangzhou, showing directly all the products and how they provide fitout services to customers.
The whole-house interior fitout business (HOMEKOO Cloud +directly operated stores) delivered revenue of Rmb194m in 2018 and Rmb155m in1H19 (+231% YoY). We see the business revenue as highly likely reach to Rmb350-400min 2019. At present, the self-operated business has received more orders than its capacity, and the number of HOMEKOO Cloud members is growing rapidly while members have started to place purchase orders from the HOMEKOO platform. With Shangpin’s strength in software development, innovative thinking, and channels expansion, we expect the segment to grow substantially and become a key profit driver for the company.
4. Unique retail thinking
4.1 Create customer profiles to outcompete peers
In the new retailing era, whoever truly understands consumers will outcompete its peers.Consumers have turned from passive selectors to active participants in the domestic furnishings market. Asa result, companies that stick to traditional manufacturing modes (focusing on products,manufacturing processes, and supply chains) and neglect retail services (focusing on branding, and consumer preference) are unlikely to stand out in the new era.We note Shangpin’s two major advantages – strong software and information technology (IT) capabilities, and a productive culture and young employees. With consumer demand in mind, the company has created a distinctive C2B and O2O business mode.
Understand and meet customer demand.Leveraging its software and IT capabilities, as well as the self-operated business mode, the company has independently developed an order management system. Based on data of key customers (demographics, family structure, apartment layout and homeprices etc.), the company has built up a consumer profile system. Compared with the peers who adopt the franchise mode, Shangpin boasts a better understanding of consumer preference (including floor space, demographics, lifestyle andcorresponding design preference, and decoration style), thus providing tailor-made designs and products.
A dynamic corporate culture caters to the new generation of consumers. The company, previously a software designer, inclines to internet thinking in operations and management.As a new comer into the furniture manufacturing industry, the company’s middle-level management, store employees,and franchisees are relatively young. For example, its employees volunteer to work until the last minute every day (the “2359” policy) and the last day everymonth (the “3124” policy), reflecting the team's vitality and hard work.Moreover, Shangpin has launched the "Design Island" incentiveplatform for designers, and attached great importance to digital marketing inorder to endear itself to the younger generation. Shangpin ranked 1st in termsof the number of fans in the whole-house customized furniture market on most majormedia platforms. The company is the first to offer free measurement services and sell its whole-house customized furniture solutions at Rmb518/sqm (a game changer in the pricing of customized furniture). With an in-depth understanding of the younger generation’s needs, we expect the company to continue to lead the industry and grasp new retail trends.
4.2 O2O marketing accurately targets the young generation
Retail mindset:targeting the young generation with online media platforms and flexible marketingtools. Thecompany's designers, the majority of which are born in the 1980s and 1990s, seeeye to eye with the new generation of home buyers, in terms of fashionable designs and color choices. The company has invested c.Rmb209m in the internetmarketing O2O platform project after going public, in a bid to conduct promotional campaigns on the PC and mobile versions of social media such as Tmall, Baidu(BIDU:US – N-R), WeChat and Weibo, aiming at their target customers (homebuyers born in the 1980s and 1990s). The current number of Shangpin’s fans on major media platforms far exceeds that of itspeers. The company has 6.82m Tik Tok fans (Shangpin and Wayes combined), vs1.56m for Suofeiya (002572:CH – BUY) and 0.3m for OPPEIN (603833:CH – O-PF). Shangpin’sWeibo fans top 2.08m. The readership of its WeChat posts averages 50k-100k,pointing to robust user activity. Shangpin has also employed key opinionleaders (KOLs, such as Guan Xiaotong) and made short videos to enhance its brand exposure. On the 2018 Tmall Singles Day shopping festival (11 November), Shangpinranked second in the whole-house customized furniture category in terms ofcustomer traffic, and sixth in terms of online sales (Rmb210m). We highlight the company’s innovative marketing strategies, catering to the demand of young users.
The O2O model guides customers to stores efficiently.After customers book free measurement services through the company’s website or WeChat account, the company willallocate the order to the nearest O-store and franchise store, and charge the franchisee a channeling fee, representing 8-10% of the order value. At present,30-60% of the customers of franchise stores come from the company’s onlinechannels, vs 60-70% for self-operated stores, greatly reducing franchisees’customer acquisition pressure. It also contributes to revenue growth, with revenue from O2O services increasing from Rmb4.03m to Rmb154m. Compared with peers, the company's marketing and advertising expenses also rank first. Itrecorded aggregate advertising and marketing expenses (including advertising,exhibitions, websites, etc.) of Rmb1.40bn in 2014-18, accounting for 6.7% of total revenue over the period, c.1.5-2.5ppts higher than peers. We believe such expenditures will continue to boost Shangpin’s brand influence, translating into effective traffic and lifting offline revenue in the future.
Meijia platform to further increasetraffic and conversion rate
In addition to major media channels, the company also established its own WeChat publicaccount Meijia to raise its customer conversion rate. Users can search for design solutions through style and home layout, among other indicators, browse various design stories and decoration guides, directly communicate with the company’s purchase guides and designers, and directly make an appointment for free measurement. As of June 2018, more than 11,000 designers have shared contents on the Meijia platform, including more than 60,000 design solutions, and the number of readers has reached 11.88m. Through this platform, the company has won more than 30,000 door-to-door measurement orders (as of mid-2018), making it another key marketing tool for the company.
Flexible marketing efforts to increase customer conversion rate. The company uses big data analysis to send relevant articles and solutions based on online and offline customers’preference and needs. Therefore, its offline and online shopping guides not only need to attract customers, but also continue to clinch a deal. The company has connected its shopping guides nationwide to the Meijia platform, where it shares excellent marketing models and design plans. It has also established ashopping guide development system based on a grade and point mechanism. Weexpect its incentive measures to improve the ability and morale of its shopping guides. The Meijia platform’s efforts to attract customers with good designs have significantly improved the conversion rate of offline stores, highlighting the value of the company’s design services. It also shows the company’s different retail strategies from traditional furniture manufacturers.
5. Earnings forecasts and valuation
We select three whole-house customized furniture companies for financial comparison (Suofeiya, OPPEIN and Zbom HomeCollection (603801:CH – N-R)). Despite similar products, we note differences in the following indicators due to different sales models (Shangpin depends more onself-operated stores, while the other companies rely on the franchise model).1) Gross margin.Customized furniture companies generally book a gross margin of over 50-60% for the self-operated business (vs Shangpin’s 60%), 30-40% for the franchise business(vs Shangpin’s 30%), and c.20% for the TOB construction business. Different revenue exposure results in a significantly higher gross margin for Shangpin (7-8pptshigher than its peers). Based on peers’ revenue structure (excluding TOBconstruction and other businesses), we estimate Shangpin’s gross margin at c.32-35%, 1-2ppts lower than peers’,suggesting further room for improvement. Currently, we note intensified competition in the customized furniture industry, and local franchisees have launchedpromotional activities or given gifts to bolster sales. However, in the short-term,we note a limited impact from the price war at retail stores on manufacturers, withthe industry’s overall gross margin dropping c.0.5ppts. We expect customized furniture manufacturers to offer rebates and discounts to franchisees in the future. Coupled with a rising proportion of the franchise business and the expanding whole-house interior fitouts business, we expect Shangpin’s blended gross margin to decrease, reaching c.42.6% in 19E, 41.7% in20E and 41.6% in 21E.
2) Net margin: substantial upside room. Shangpin’s blended net margin is c.8pptslower than peers’ due to high costs of the self-operated model, including rental(accounting for 3% of revenue), employee remuneration (14%), shopping mall advertising expenses, and decoration expenses. Given a large number of designers employed by each self-operated store (dozens to hundreds of designersper store) and considerable store rental costs due to large floor areas, the company's net margin of the self-operated mode is 3-4ppts lower than that of the franchise mode. Meanwhile, the company's advertising expense-to-revenue ratioexceeds that of peers by c.2-3ppts. In the future, with rising revenue exposure to the franchise business, we expect the company’s selling expense-to-revenue ratio to decrease, driving up net margin. From a sensitivity analysis, we find that Shangpin’s shopping mall stores with higher revenue ceiling generate much higher net profit margins than furniture department stores. However, in apessimistic scenario, shopping mall stores have more fixed expenses which will significantly drag down the profitability of distributors.
3)Prepayments from customers. Under the self-operated mode, the company recorded huge prepayments (Rmb1.16bn as ofend-9M19), with a significantly higher prepayment-to-revenue ratio than its peers. On the other hand, as the company expands the whole-house interior fitout business (it started the business in 2H17), customers will make full payments inadvance, while HOMEKOO Cloud members will pay deposits. As such, we expect the company’s prepayments from customers to continue to increase in the future,resulting in a higher equity multiplier.
4)DuPont analysis:Shopping mall stores generate high revenue and turnover. Prepayment in self-operated mode incite higher equity multiplier. However, the higher costs inherit withself-operated business lead to lower net profit margin.
Net margin:Shangpin’s net margin is 50% lower than peers’ dueto the higher revenue contribution from its self-operated business with higher gross margin, more SG&Aexpenses, and lower net margin.
Turnoverrate: Shangpin records a high total asset turnover due to the following reasons. Largeexposure to the self-operated business results in higher revenue than peers(revenue recognition under the model is nearly twice that of franchising).Meanwhile, about half of the company’s stores are shopping mall stores, enjoying significantly stronger sales per store than peers (around twice the sales of peersin terms of franchise stores). In addition, accessory home furniture sales boast higher sales per order and per store compared to peers, thanks to itsfirst-mover advantage and an asset-light model based on OEM and consignment sales.
Leverage: Without long-term loans, thecompany’s prepayments from customers has exceeded Rmb1.1bn, resulting in higher current liabilities and equity multiplier than peers. After the company obtained the IPO funds in 2017, its total assets and owner's equity increasedsignificantly. However, such funds have not yet been effectively converted into revenue, resulting in a decrease in total asset turnover and equity multiplier.
To summarize, continuous innovation in business model and retail mindset help Shangpin to stand out in terms of operating efficiency and leverage utilization.However, lower net margin has led the company’s ROE to stand at the industry average currently. Withrising revenue exposure to the franchise business and dropping expense-to-revenue ratio, we expect the company’s net margin and asset turnover rate to further pick up in the future, with ROE likely to reach 16.4% in 19E, 17.1% in 20E, and17.6% in 21E.
Relativevaluation
In terms of relative valuation, we select seven companies in the whole-house customized furniture industry as comparable companies, namely Suofeiya, Oppein, Zbom (603801:CH-N-R), Holike(603898:CH-N-R), Golden Home (603180:CH-N-R), Olo Home (603326:CH-N-R) andPiano (002853:CH-N-R). These companies are similar to Shangpin in terms of product offerings (customized cabinets), but most of them adopt the franchise model,and only have a small proportion of self-operated and TOB construction business. Despite that, they share strong similarity with Shangpin.
Revenue. Shangpin is committed to channel innovation (opening shopping mall store, C-store), O2O marketing, enhancing interior design ability and developing whole-house interior fitout business. Weexpect revenue growth to maintain at 10% or above in the next few years.
Profitability.The increasing proportion of franchise stores is likely to push up net margin, whilethe whole-house interior fitout business is still in the infant stage and thus will likely drag down the company's overall profitability. We expect bottom-line growth to outpace top-line growth with the slowdown of SG&Aexpenses. We forecast net profit of Rmb569m in 19E (+19% YoY), Rmb681m in 20E(+20% YoY) and Rmb801m in 21E (+18% YoY).
We see Shangpin’s retail- and IT-based mindset makes it different from peers. It is actively innovating in channels and business models. Once thewhole house interior fitout business develops smoothly in future, we expectit to bring additional growth driver for the company. We are also positive onits unique competitive advantages interms of IT and designing capability. Design is the key to customer conversion. Shangpin has established a strong advantage in design which isdifficult for peers to surpass in the short term. In addition, as the firmshifts to the franchise model, coupled with narrowing operating expense-to-revenue ratio and the potential breakeven of whole-house interior fitoutbusiness, we see further upside in profitability.The company is trading at 25x 19E PE, 4.3x 19E PB, and 1.3x 19E PEG, higher than the industry-average level, which we see as reasonable given its business model. However, its 19E price-to-sales (PS) ratio is only 1.9x, significantly lower than peers. We believe that the company's profitability is stillon an upswing, with a larger upside for net margin. As such, we considerPS ratio as a better valuation method for Shangpin. We derive our target price of Rmb92.47 based on 2.5x 19E PS. With 28.5% upside, considering the potential downward effect of mismanagement of franchise channel, we initiate coverage of the stock
with an Outperform rating.
6. Appendix
【申万