Gree:Potential slowdown in 2H18
Strong 1H18 growth, but weaker margins: Gree’s AC segment, which comprised ~80% of total sales, grew 38.8% YoY. Gree indicated that sales growth was faster in Tier 3/4 cities for the period. In spite of strong top line growth, gross margins in the AC segment contracted 410bps on account of increased raw materials prices and low utilization at a new Changsha factory. Gree negated the impact of gross margin compression and by cutting selling expense by 350bps to 8.7%, a historical low, which may prove unsustainable in our view.
AC growth decelerating in 2H18: Midea, Gree, and Qingdao Haier all experienced negative growth in AC sales in July due to high base effect and weather. We understand Gree experienced singled digit negative volume/sales growth in July due to high base and weather effect. In August, negative growth has moderated to approximately flat growth YoY. This trend is consistent with our channel checks and reporting from other home appliance manufacturers.
Dividend disappoints: Gree announced a proposed interim dividend of RMB3.6bn, indicating ~30% payout ratio for 1H18. This is less than our and market expectations of ~50% payout, and below Gree’s historical payout ratio of ~60-70%. Gree has not provided clear guidance on whether it still intends to pay a delayed dividend on 2017’s earnings. Gree has also not provided further clarity on where it intends to invest its cash reserves.
Inventory levels under control: Gree’s factory and channel inventory remain seasonally low, according to the Company. Similarly, channel inventory levels of industry competitors also remain well controlled.
Inexpensive valuation. In spite of a strong 2018H1 top line, we remain cautious about Gree’s 2018H2 in light of low visibility on AC sales, the lack of new discernible long-term growth drivers, and an inconsistent corporate strategy. Gree derives ~88% of its revenue from China, making its earnings almost wholly reliant on the domestic China market. On this basis, we believe Gree warrants a discount relative to its peers Haier and Midea. We cut our 2018/2019 EPS estimates by 5.7%/11.4% and value the Company at 9.5x PER, implying a 12-month target price of RMB42.6, or ~9% upside.