MIDEA GROUP:3Q18Conference call takeaways
Midea reported 3Q18 results, with top/bottom line growing 1%/18% respectively for the quarter, vs. 10%/19% for 9M18. With revenue growth facing macro headwinds and ASP growth (consumer upgrade) stalling in the AC segment, we think the stock is likely to remain under pressure. We have cut our 2018/2019 EPS by 3%/17% respectively, and reduce our PT from RMB 53 to RMB 42.
Investment Highlights
Profit boosted by finance income, operating profit disappoints: Total revenue rose 1% YoY, with net profit growing 18% YoY on account of gross margin expansion and reduced finance expense. Midea’s 3Q18 top line fell short of our expectation for mid-single digit revenue growth in second half. PBT growth of 24.5% for the quarter was supported by improvements in finance costs. Underlying operating profit grew only 9% (See Figure 1).
Upgrade trend slowing in AC: Midea’s gross margins increased to 28.1%, up from 25.9% a year ago. Mgmt indicated AC growth of ~18% YoY in 9M18, suggesting negative growth for AC in 3Q18 based on 28% AC growth in 1H18. ASP increase was flat for 3Q18, vs. ~10% growth in 1H18. This remains a key concern, as consumer upgrade and margin expansion has been part of our Midea thesis.
Low channel inventory: Midea’s AC inventory remains well controlled, with 1-2 months of combined total factory and channel inventory, or approximately 5 million units. In other appliance segments, Midea also reports that channel inventory is near historical lows. While we believe there is a high probability of revenue weakness into 4Q18, we don’t believe Midea’s AC industry channel inventory levels are reminiscent of 2015 levels, when destocking led to a sustained sales contraction.
Inexpensive Valuation. With ~35% sales from international sources (ex KUKA) and lower ASPs relative to Gree and Qingdao Haier, Midea remains well situated to ride out a slowdown in China’s home appliance market. Currently trading at 11.1x 2019E PER, we expect Midea to post 21%/0% EPS growth in 2018/2019, down from our former estimates of 21%/11% EPS growth. Our 2018/2019 earnings have been reduced by 3.5%/17.2% respectively. Our new TP is based on a valuation of 13x 2019 EPS, down from our former 15x, which we believe is justifiable for a business with a diversified franchise, stable market share, and high single digit earnings growth.