CITS Alert:Secured eight years’duty-free license for T2&T3of BCIA;lifting TP;Buy

CITS has acquired 51% of Sunrise, and secured both T2& T3duty-free of BCIA.

    We reiterate our Buy rating on CITS and raise our TP to RMB 37from RMB32.5. CITS announced that it has acquired a 51% stake in Sunrise China for aconsideration of RMB 38.8m at a 1x PB. Sunrise China is the sole duty-freeoperator of Beijing Capital International Airport for T2and T3. CITS alsoannounced that Sunrise has extended its license to operate T3, and CITS(subsidiary: China Duty Free Group) has won the license to operate T2for thenext eight years. Sunrise will be consolidated into CITS for 2H17.Incremental earnings for CITS will start in 2H17, raising our TP to RMB 37.

    Sunrise’s duty-free revenue was RMB 4.4bn and net profit was RMB 377m in2016. We assign 15% growth for the duty-free sales of BCIA in 2017E andconsolidate 2H17earnings to CITS. Although the concessionaire rate forbidding for BCIA seems high, we believe the margin improvement will bedriven primarily by the following: 1) Sunrise and CITS will have mutual benefitfrom each other’s competitive advantages: CITS has higher negotiation powerin the tobacco channel while Sunrise’s competitive edge is in operatingcosmetic products; and 2) economy of scale: CITS’ total duty-free sales willincrease by almost 40% after consolidating Sunrise. As a result, CITS will havemore negotiation power over its duty-free suppliers.Outlook thereafter? T4of new BCIA and Shanghai HQ/PD airport?

    We believe winning the BCIA airport is a milestone for CITS to expand itsfootprint in all the primary airports in Greater China. Since the merger of CITSwith China Travel Group, we observe that CITS has been more aggressive andfocused more on its duty-free business. With the new BCIA under constructionand Shanghai Pudong/HongQiao airport’s duty-free license to expire next year,we are confident that CITS will be active in winning the duty-free businessthere.Valuation and risks.

    We believe CITS’ valuation is very attractive at 23x/20x on our 2017/18earnings forecast, as duty-free is a policy-protected and high-barrier-to-entrybusiness in China. CITS’ valuation is lower than average retail/travel peers in Ashares. Our TP of RMB 37converts to a forward PER of 25x on our 2018earnings forecast. We derive our RMB 37TP from a DCF-based valuation(8.1% WACC, 9% cost of equity, beta of 0.9and 3.0% TGR, unchanged). Keydownside risks include: 1) unfavorable government policy, 2) e-commercecompetition, 3) delay in lifting shopping quota, and 4) competition from OTAs.