China Resource Enterprise (291, $25.15) is under hard recovery – Maintain SELL

China Resource Enterprise (CRE) announced disappointing financial results for 1Q13. Total turnover was up 8.4% yoy whereas underlying net profit dropped 8.6% yoy to $512mn. The bottom line was below market expectation. We know from historical trend that retail division accounted for over 80% of total underlying net profit in first quarter. So the weak retail segment with low CPI in China made recovery harder for the company.

Retail division turnover increased by 7.3% yoy in 1Q13, supported by 2.9% SSSG and 378 new stores opening (9% yoy increase). Dragged by losses from new stores, underlying net profit margin dropped 0.3ppt to 2.0%. The result underperformed Sun Art Retail (6808), whose SSSG in 1Q13 was 3-4% with a slight improvement in net profit margin. What disappointed us is the weak performance of new stores, which provided lower-than-expected productivity and needed longer time to mature. The management did see some improvement in 1Q13, such as losses from North East region decreased from $90mn to $80mn, but still anticipates lower underlying net profit margin in FY13 (excluding 80-100mn one-off expenses in FY12).

Beer sales volume increased by 16.2% yoy in 1Q13, better than its major competitors. ASP dropped 2.5% due to aggressive direct promotion leading to a 13.3% increase on turnover. Underlying net profit margin also improved from -0.6% to -0.4%. Given a high base in 2Q12, volume growth is expected to slow in 2Q13. ASP will continue to trend downward at least till mid-2013. Company will decide on whether to shift back the promotion strategy to normal level after reviewing its overall 1H13 results. Despite better result of beer division in 1Q13, the management kept its full year sales growth guidance unchanged at 5-10%.

Food division is still under reconstruction after the disposal of marine fishery in FY12. Due to this effect, sales dropped 5.7% yoy with underlying net profit margin slightly increased. Seeing the weak consumption sentiment, the company will endeavor to keep sales and margin stable in FY13. As a long term strategy, CRE will search for more synergy between retail and food division. Beverage division recorded large sales growth of 56.4%, supported by large investment in A&P for Kirin products (~$80mn in 1Q with full year target of <$200mn).

CRE’s disappointing 1Q13 result confirmed our view of weak recovery. We revised down our FY13E underlying EPS by 3% to $0.76. Counter is in a down trend and has dropped 6.3% since our last Sell call on May 6, but it is still equivalent to an expensive forward PER of 33.3X. Maintain SELL with target price of $22.65