Xiabuxiabu Earnings: Management Lowers Guidance on Pricing and Margin Headwinds

We trimmed our fair value estimate for no-moat Xiabuxiabu 00520 to $4.7 per share from $4.9, after management lowered full-year 2023 guidance. While softening macroeconomic conditions are certainly a factor, the business’ underperformance in same-store sales in China is concerning. With Xiabuxiabu being the only restaurant operator under our coverage that lowered unit opening guidance for 2023, the business seems to be facing more challenges than its peers. We still think Xiabuxiabu’s shares are undervalued, but we believe continued profitability concerns could create a more attractive entry point. We recommend investors wait until ongoing macroeconomic weakness is fully priced before buying Xiabuxiabu.

In the first half of 2023, revenue increased 32% year over year. The restaurant industry is one of the biggest beneficiaries of China’s reopening, and Xiabuxiabu’s sales growth shows how quickly the industry is recovering from lows in 2022. That said, China’s weak macroeconomic conditions remain an overhang on restaurant sales, evidenced by the group’s same-store sales still trending significantly below the prepandemic level. The group opened 67 net new units in the first half, translating to about 7% restaurant unit growth compared with the end of 2022. But management sounded downbeat on the second-half outlook and lowered Coucou’s opening target to 45 from 70.

Despite the jump in sales, the firm still incurred operating losses of CNY 27 million for the period. Looking at individual cost items, staff cost as a percentage of revenue remained elevated at 33%, versus just 27% in 2019. We think this is mainly a reflection of deteriorating unit economics at the premium Coucou chain (50% of revenue). We expect an operating profit in the second half as the group gradually pulls back from promotional activities. Our valuation for the company assumes a midcycle operating profit margin of 4.4%, roughly half of what it achieved prior to the pandemic.