GREE ELECTRIC(000651)：CHANNEL REFORM DRIVES EXCESS RETURNS

The channel stuffing system gave Gree Electric an edge in business expansion。 However， as retail undergoes a transformation in a time of change， the old model is no longer relevant。 As channel reform enters a deep water zone， challenges such as outdated warehousing， logistics and information system and entangled channel interests， await Gree。 However， Gree is catching up fast by exploring a “self-built+third-party” logistics model， and its efforts to “pare tier-1 distributors” have initially paid off。 The AC industry still has headroom for development in the long-term。 A successful channel reform should enable Gree to shore up its core competitiveness and long-term corporate value。
Revisiting channel history： the acclaimed “Gree model”。 Gree‘s growth coincides with the development of China’s AC industry， during which Gree establishes a uniquely competitive channel model。 From 1994 to 2004 when the demand for ACs grew exponentially， Gree preliminarily set up a channel system comprising joint-stock regional sales companies， and invented the sales rebates policy to fully motivate channels and to make them stand out from fierce competition。 From 2004 to 2012， riding on the “Home Appliances to Rural Areas” initiative， Gree penetrated into lower-tier markets with its self-built channels， and tightly bound channel interests through its sales rebate policy and ownership structure。 During this period， its revenue and net profit grew at a c。 10Y CAGR of 28。1% and 42。9%， and an industry leader was in the making。 From 2012 to 2017， driven by the property boom， Gree held the largest market share in all tiers of markets through the Shengshi Xinxing system， way ahead of its peers and second to none。
Dilemma： collision between old channels and new changes。 With the rise of e-commerce， a higher proportion of AC replacement and upgrade and weakening seasonality of AC sales， the traditional distributor stuffing model was heavily shaken up。 Midea took the lead in channel reform， streamlined the hierarchy， and accelerated digitization， which greatly strengthened channel efficiency and its perceptiveness to end demand。 After the reform， the price gap of end products between Midea and Gree widened， and their market share difference quickly narrowed。 During the same period， Gree tolerated a high channel markup rate to protect distributors and played it safe with online expansion。 Consequently， the old channel was dragging on Gree’s new retail transformation。 From 2019 to 2020， Gree came clearly under pressure， with its revenue growth stagnating and profit declining 5。7/10。2% YoY。
Channel reform： actively exploring the new retail model。 Gree‘s ongoing round of channel reform can be divided into three stages。 The first stage focuses on straightening out the channel framework， reducing the channel markup rate （5-10%）， and making up for deficiencies， which was largely completed。 In the second stage， Gree was committed to piloting new retail formats， streamlining channel hierarchies， further releasing channel profits （5-10%）， promoting online and offline integration， and improving digital system construction to lower cost and improve efficiency。 These know-hows will be popularized in the third stage。 “Change is the only constant in life。” At present， Gree is in a critical stage of new retail transformation， with opportunities and challenges sitting side by side： 1） the first challenge： given Gree’s outdated warehousing， logistics and information system， the supporting facilities for retail transformation urgently needs to be improved。 In light of this， Gree stepped up warehousing construction， leveraged social logistics resources through the model of self-built trunk logistics+outsourced branch road logistics， and launched its wholesale online app to move channel information online。 Such a change cannot be achieved overnight， reflecting Gree’s determination； 2） the second challenge： to straighten out and align channel interests in the process of paring down hierarchies。 Paring down channel profits and hierarchies will inevitably hurt distributors’ interests， and disentangling interests can help break the deadlock。 Accordingly， on the one hand， Gree retains high dividends to stabilize distributors’ interests； on the other hand， the company accelerates the transformation of major provincial sales companies， and established distributors may be phased out。 Based on the feedbacks of advance receipts， Gree has straightened out the interests of most regions， and the overall risk is controllable； 3） opportunity： once Gree moves ahead with the reform， the price gap between Gree and its peers is likely to converge， thus improving the comprehensive competitiveness of its products。
Looking ahead： the industry is not very pessimistic， and Gree seeks a breakthrough。 We estimate that domestic AC sales will grow at a low single-digit CAGR （+3%+plus） for 2021E-2025E。 In the long run， there is room for improvement in the sales volume and price of ACs in China。 1） In terms of the sales volume， we expect the steady-state sales to top 100mn units/year based on province-specific calculations， implying a c。 20% upside relative to the current sales volume of more than 80mn units。 2） In terms of price， compared with Japan， we expect that with the cannibalization of existing AC market， AC price will continue to rise on improved energy efficiency and structural optimization。 So far， China still lags behind Japan on AC energy efficiency， and a higher proportion of fresh air AC and multi-split AC for households will provide leeway for price markups。 On a corporate level， branding and economy of scale remain the biggest barriers， and we look forward to the improvement of competitiveness post the channel reform。
Potential risks：
Gree’s channel reform progressing slower than expected； raw material prices continuously rising； regional COVID-19 resurgence exceeding expectations； property sales data coming weaker than expected； industry price war more intensified than expected。
Investment strategy：
Channel reform is an inevitable attempt and adjustment that Gree has to make in the new retail era， and how it’ll evolve is worth tracking and watching out for。 If the channel reform moves ahead as planned， Gree’s operating efficiency will gradually improve， its channel markup rate will be effectively reduced， and the competitiveness of end products will be enhanced。 In addition， Gree maintains a high dividend policy and has abundant cash on hand， underscoring its value for long-term asset allocation。
We maintain our 2022E/2023E/2024E EPS forecast of Rmb4。09/4。51/4。94。
According to its 2022-2024 shareholder return plan， Gree currently has a dividend yield of over 6% at its current share price。 Also， considering that the sales volume and price of the AC industry have yet to hit the ceiling， we expect solid growth in the company’ profit over the next three years。 Considering the average 2022E PE of Midea Group （000333。SZ）， Haier Smart Home （600690。SH/06690。HK） and Hisense Home Appliance （000921。SZ）， and Gree’s business structure， revenue， profit growth forecasts and margin of safety， we assign 10x 2022E PE to derive a target price of Rmb41。 Maintain the “BUY” rating。
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   【免责声明】本文仅代表第三方观点，不代表和讯网立场。投资者据此操作，风险请自担。