Nationwide Home Furnishing Malls Operator

Red Star Macalline is the leading developer and operator of shopping malls primarily focusing on home improvement and furnishing retailing sectors. In 1H2016, Red Star Macalline operates 181 malls, with 56 portfolio malls and 125 managed malls. The total operating area for portfolio malls and managed malls are 4,457,050 square metres and 7,357,877 square metres respectively. Moreover, Red Star Macalline has established strategic presence in almost the entire countries, spanning across 27 provinces, municipalities and autonomous regions and across 129 cities across China. According to the chart below, Red Star Macalline's portfolio malls span across the countries, and are mainly located in Tier 1 and Tier 2 Cities. In particular, Red Star Macalline has set up 18 of its portfolio malls in large cities such as Shanghai, Beijing, Tianjin and Chongqing, with total operating area 1,507,803 square metres, contributing to about 34% of the total operating area of the portofolio malls.

At the same time, Red Star Macalline has been actively expanding to the whole country by establishing managed malls across the countries. Shopping malls are established in provinces or autonomous regions such as Fujian, Anhui and Xinjian. In contrast to portfolio malls, managed malls have a lower strategic presence in large Tier 1 and Tier 2 cities, as evident in Shanghai, Beijing, Tianjin and Chongqing having only 109,693 square metres of operating area, contributing only 1.49% of the total operating area of managed malls.

Huge Project Reserve

The shopping malls of Red Star Macalline regularly achieves high occupancy. Ever since 2013, both portfolio malls and managed malls have achieved an occupancy rate of over 90% consistently. Moreover, the management agreement of the managed malls are usually long term, with most of them lasting as long as 10 years. The long term management contract allows Red Star Macalline to generate stable income in the long term. Moreover, Red Star Macalline also benefits from the incremental increase of rental income as time progresses, enabling it to hedge against the effect of inflation.

The floor area of both portfolio mall and managed mall is rapidly increasing. According to the chart below, the operating area of portfolio mall has increased 39.2% in 3.5 years while the operating area of managed malls has increased 34.9% in 3.5 years.

Until 1H2016, Red Star Macalline entered into agreement for 488 managed malls, with 279 of the managed malls projects have their land secured. Shopping mall construction is a long term project and is expected to take several years of time to complete the construction. Therefore, we expect the underlying value of the shopping malls only to be realized in the long term.

Financial Outlook

Portfolio malls` gross profit margin increases from the initial 73% in 2012 to 77.3% in 1H2016 while managed malls` one decreased from the highest 75.8% in 2014 to 69.3% in 1H2016, the lowest in recent years. The decrease in gross profit margin of managed malls is caused by the decrease in the opening of new malls, which Red Star Macalline would be able to recognize consultancy fee in construction, usually having higher profit margin than ordinary management fee.

The following graph is the revenue composition by different business segments of Red Star Macalline:

Because of the drop in gross profit margin of managed mall segment, we expect Red Star Macalline would be affected in general, mainly in terms of the short term growth, for the reason as follow:

- Mall development is a long term project, implying the high margin consultancy fee income , one of the important driver of growth, taking long time to realise its value

- Managed mall segment contributes to about 30% of the total revenue on average across years

We expect, however, revenue would remain stable at current level because of the nature of the business.

- Management fee and rental income are stable

- At managed mall segment, Red Star Macalline has the priority to collect the fee due to it from the rental payment payable to the landlord before handing over to the landlord

Besides, Red Star Macalline has a stable net profit margin but has a relatively volatile operating cash flow margin. We notice that the reason for such volatility is caused by the drop in working capital, which is in turn caused by an increase in receivable. In particular, bad debt provision is 26.6% of the total receivable in 1H2016. After making provision for the bad debt, most of the receivables are with age less than a year. Since operating cash flow margin has started diverging with the net profit margin, the aging receivable may soon cause a problem in the company's financial position.

Healthy Debt Ratio

Although the company has a large proportion of bad debt provision, its gearing ratio is healthy. Red Star Macallin has been actively preparing and launching shopping malls. As at the reporting date of 2015 annual report, Red Star Macallin expects that there will be 9 new additional portfolio mall, and the company will continue its strategy of focusing on Tier 1 and Tier 2 Cities. As at the reporting date of 1H2016 report, the company has entered into agreement for 488 malls.

Despite its rapid expansion, Red Star Macallin has maintained its gearing ratio well, with long term debt to equity ratio being around 40%. At the same time the total number of malls has increased from 115 malls in 2012 to 181 malls in 1H2016, a 57.4% increase.

Valuation

With the rapid expansion of the company's presence in the country via setting up both portfolio and managed malls, we expect the company to continue growing in the long term particularly because of its project reserve. The peer average P/E, P/B, and P/S are 6.70x, 1.09x, and 1.22x respectively. Red Star Macallin's target price is therefore $9.40, with Buy rating assigned. (Closing price as at 20 Dec 2016)

Risk

Lag in recognition of growth due to long term project nature

Bad debt increases

Financials

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