Luolai Lifestyle Technology:Good operational quality;likely to benefit from improving demand from relocations

We expect weak recovery in offline demand

    A weak demand recovery has followed the industrywide destocking of recent years.

    The department store channel has remained under pressure. Home textile sales at largeretailers have continued their downward trend YTD, although the declines havenarrowed compared with last year. Historically, growth in home textile industry saleshas been highly correlated to the previous year's property sales growth. Since the startof the year, property sales have rebounded further, with cumulative growth of 34.2%in 5M16. We expect home textile demand from relocations to improve gradually.

    Good operational quality; clear transformation strategy

    Luolai has had an earlier rebound in revenue growth than peers and better operationalquality, in addition to faster inventory turnover and healthy cash flow. With destockinglargely completed, the company could be among the first to benefit from a demandrecovery, in our view. The company has completed the acquisition of 12 franchisees aspart of its effort to take direct control of sales outlets. It has also been expanding itshome furnishings offerings. Its brands have opened a combined 100+ home furnishingretail outlets. On the product front, a combination of independent R&D and resourceintegration via acquisitions (eg, acquisition of the ownership of Japanese high-endtowel brand Uchino in China) shows the company's steadfast and clear push fortransformation.

    Further improving online home furnishing ecosystem

    On the online strategy side, we think the biggest difference between Luolai and rivals isthat the company has built its own e-commerce brand. With replacement demand forhome textiles rising, consumers prefer more affordable products with lower mark-upsand the online channel is the key to meeting this demand. As an independent ecommercebrand under Luolai, LOVO can help avoid conflicts of online/offline interestand capture these new customers. In addition, as part of its investment-driven pushinto "internet plus" segments, the company has partnered with industry leaders andinvestment agencies to enter the smart bedroom furnishing field, further improving itsonline home furnishings ecosystem.

    Valuation: Slightly cutting PT to Rmb16.9, Buy rating

    Given sluggish retail sales in H1 and Luolai's faster-than-expected expense growth, weare lowering our 2016-18E EPS to Rmb0.63/0.72/0.82. Our new DCF-based PT isRmb16.9 (WACC cut to 9% from 9.2%) and we maintain our Buy rating.