It was hard to wait for offline traffic, yet China China Free (601888.SH) faced double pressure from exchange rates and rents in the first half of the year.

On August 24, China China Press released its semi-annual report for 2023. In the first half of the year, it recorded revenue of 35.859 billion yuan, an increase of 29.68% over the previous year; net profit of 3.866 billion yuan, a decrease of 1.83% from the previous year, continued the weak performance of increasing revenue and profit in the first quarter.

During the reporting period, due to the rise in the US dollar exchange rate, the operating costs of China's exemptions rose at a much faster rate than revenue, and procurement costs also soared. As a result, profit performance was under pressure, and gross margin fell 3.37 percentage points to 30.61% over the same period last year.

Although international passenger traffic is gradually recovering, the rent that China exempts from paying to the airport has also risen sharply. In the first half of the year, its holding company Sun went to Shanghai (which operates duty-free business and online taxable business at Shanghai Airport) recorded revenue of 8.197 billion yuan, but only contributed 8.388 million yuan in net profit, a sharp decrease of 96.59% over the previous year.

The market had anticipated this for a long time. Since this year, China China Free's stock price has declined in a slippery manner. As of August 24, it had dropped 47.81% to close at 111.95 yuan/share. Furthermore, following Pan Feilian in the second quarter of last year and Chen Fashu in the first quarter of this year, Niu San, and Liang Ruian, who are the only remaining in the top ten shareholders of the Chinese exemption, are also leaving the market. During the reporting period, its position was reduced by 46.69%, and its shareholding ratio fell from 0.66% to 0.35%.

TradeWind01 (ID: TradeWind01) called China Securities Debit to ask questions such as profit improvement plans for the second half of the year, but the other party was unable to respond to related questions.

Double pressure

Looking at it now, China's performance has improved ahead of stock prices, yet it still faces double pressure.

The first pressure comes from the slow recovery of consumer spending power.

China's return to growth in the first half of the year was mostly influenced by the low base figure for the same period last year. It recorded revenue of 35.859 billion yuan in the first half of this year, up 29.68% year on year, but compared to the same period in 2021, it only increased 0.94% year on year.

Compared to the first quarter, China's China Free Company showed some recovery momentum in the second quarter, but revenue and net profit still fell 27.35% month-on-month? 42.97% still indicates to a certain extent that it is still in the “weak recovery” phase.

There are more people going to Hainan, but they are spending less money.

During the May Day holiday this year, the Hainan duty-free market, which is the basic market for China exemption, achieved sales of 883 million yuan, an increase of 120% over the previous year; the number of shoppers reached 109,000, an increase of 158% over the previous year. However, compared with 2021, sales and number of shoppers fell by 11.1% and 9.9%, respectively, and the unit price per customer also fell by 1.3%.

A private equity person in East China who has been tracking the consumer industry for a long time told TradeWind01 (ID: TradeWind01) that the biggest loss in consumption power in the past year was actually the middle class. This is exactly the core consumer group of China exempt; on the contrary, top-level spending power has not been greatly affected.

The second biggest pressure comes from cost.

Since exchange costs have been high for a long time, the procurement costs of China's exemptions also remain high. In the first half of this year, its operating costs increased sharply by 36.3% year on year, far faster than the 29.68% growth rate of revenue. This also led to China Free's gross margin of 30.61%, a decrease of 3.37 percentage points from the previous year.

At the same time, along with the resumption of international passenger traffic, in accordance with the “Supplementary Agreement” signed between China and China's China Exemption in 2021 with Shanghai Airport, Capital Airport, etc., the “rent accounting” between China Free and the airport has changed from a model where actual sales commissions and guaranteed distribution commissions are raised to a guaranteed basis based on actual passenger flow.

This also means that with the resumption of international passenger traffic, China exemption will pay more rent to the airport.

In the first half of this year, China Free's sales expenses increased sharply by 126.06% year on year to 4.274 billion yuan. This is due to “an increase in rental costs due to the resumption of passenger flow at key airports, and also due to a low base affected by rent relief in the same period last year.”

During the reporting period, China Exempt's holding company Sun recorded revenue of 8.197 billion yuan in daily Shanghai (which operates duty-free business and online taxable business at Shanghai Airport), but only contributed 8.388 million yuan in net profit, a sharp decrease of 96.59% over the previous year. Net interest rate was only 0.1%, compared to 4.5% for the same period last year.

Therefore, it is not difficult to understand the news that Shanghai Airport (600009.SH) and China are exempting resignation from the market. The news says that the percentage of points deducted at the airport will be lowered.

A person from an agency close to China's China exemption once told TradeWind01 (ID: TradeWind01) that currently the market's expectations for airports to reduce duty-free deductions have been formed, and the current controversy is “the specific deduction ratio.”

After the news went viral, on August 21, Shanghai Airport and Baiyun Airport (600004.SH) both hit a halt. Although the two issued separate clarifying announcements denying the news of the reduction in the deduction ratio, stock prices were still lying on the floor, with both falling more than 8% on the same day.

Earlier, at the annual results briefing in May of this year, Wang Xuan, the director and general manager of China China Free Trade Association, also answered “the agreement has not been re-signed” in response to a question from TradeWind01 (ID: TradeWind01) about the agreement with the airport.

Profit is needed in a “weak recovery”

Under heavy cost pressure, China exempted the first half of this year while adjusting channels and clearing inventory in an attempt to “squeeze out” more profits.

On the channel side, there are difficult problems to solve due to the resumption of offline passenger flow and the fact that the online tax-free channels themselves in China have low gross profit and compete with duty-free channels.

In the first half of this year, China's exemptions “rebalanced” the share of tax-free and duty-free channels once.

During the reporting period, sales of duty-free goods contributed 23.957 billion yuan to revenue, an increase of 47.9% over the previous year, accounting for 66.86%; sales of taxable goods contributed 11.678 billion yuan, an increase of 4.7% over the previous year, and a decrease of 8 percentage points to 32.59%, reversing the situation where sales of taxable goods exceeded duty-free sales in 2022.

Furthermore, the trend of increasing duty-free channels is expected to continue. According to CICC's research report, many fragrance brands, including Estée Lauder and Shiseido, are optimistic about duty-free channels.

A social service industry analyst at a brokerage firm in the southwest region told TradeWind (ID: TradeWind01) as an example of Estée Lauder, where duty-free channels account for nearly 30% of revenue. He expects that in the future, the brand will not reduce its investment in duty-free channels due to weak sales through taxed channels. Furthermore, the person mentioned above said that Estée Lauder will support Hainan more strongly than South Korea.

On the other hand, in terms of clearing inventory, China has begun to reduce discounts and “kill people” on proxy purchases.

The analyst mentioned above told Traffic Feng that since this year, the Hainan government has been very aggressive in cracking down on proxy purchases. This will have some impact on duty-free shops in Sun and Moon Plaza, but the impact on Haitang Bay is limited.

According to statistics from Haikou Customs, in the first half of this year, the amount of duty-free shopping on the outlying islands was 26.318 billion yuan, an increase of 24.4%; the number of duty-free shoppers was 3.733 million, an increase of 45.4% over the previous year, but the per capita spending amount was only 7050 yuan, which is significantly lower than 8,262 yuan in 2022, indicating a decrease in the number of purchasers with higher unit prices per customer.

The clean-up of proxy purchases has not only freed up the backlog of channel inventory in the market, but also made it easier for China to avoid clearing its own inventory. In the first half of the year, its inventory level increased by only 3.35% year on year, and the number of days of inventory turnover decreased by 24.43 days year over year to 189.47 days.

In addition to this, China and China are also adjusting the pace of purchases of high-margin products. The analyst mentioned above told Trafon that now the purchase cycle for perfumery products is adjusted from March-April to 2 months, and alcohol and watches are 4-5 times a year. “Bargaining rights are definitely the best among duty-free merchants.”

Another brokerage analyst in the social services industry in the southwest region told TradeWind01 (ID: TradeWind01) that it is expected that the product structure will be adjusted in the second half of the year, such as increasing the proportion of high-margin products such as tobacco, alcohol, jewelry, and watches, and introducing domestic fragrance brands.

Under some manipulation, China's gross profit margin showed a month-on-month growth trend for two consecutive quarters in the first half of this year. Following an 8 percentage point increase in gross margin in the first quarter, gross margin increased 3.8 percentage points month-on-month to 32.83% in the second quarter, but it is still down from 33.95% in the same period last year.