A big question as China Paradise talks of potential but not results

PUBLISHED : Wednesday, 16 August, 2006, 12:00am
UPDATED : Wednesday, 16 August, 2006, 12:00am

'Boosted by China's rising economy and the increasingly strong domestic demand stimulated by the 11th Five-Year Plan of the PRC government, the retail market of household appliances in China offers enormous growth potential.'

Interim results announcement,

China Paradise Electronics Retail

YOU KNOW WHAT to expect when a company talks of potential rather than achievement in a results announcement.

Sure enough, the buoyant prognosis in this case was followed in the same paragraph by complaints of intensified competition and cutthroat discounts, which 'served as catalysts to accelerate the pace of industry consolidation'.

There you go, enormous growth potential and accelerated industry consolidation in the same breath.

Yes, another red-chip darling of the stock market has hit the skids with a 90 per cent plunge in earnings, saved from reporting losses only by selling some of its subsidiaries at an opportune time.

The table gives you some key comparative figures from the results announcement.

They show just how fiercely the pressures on this typical mainland retailer are mounting and how little the company can do about it.

Selling and distribution costs - I thought there were supposed to be economies of scale in being a big retailer. The bigger you get the more you can reduce your selling costs per dollar of sales. It seems to have worked the other way round here. Selling costs were up 91.4 per cent on a 35.5 per cent increase in revenue.

Minimum lease payments - A 125 per cent increase in rental costs is a very big figure indeed, particularly when the bottom of the table shows you that the total store area rose by only 27 per cent. It seems that landlords alone have enjoyed the benefits of the enormous growth potential to which China Paradise refers.

But not to worry. The company knows how to deal with this problem. It has 'demanded rental reduction so as to increase operation efficiency'. Demanded, you hear. The landlords will have no option now but to lower their rents again. We shall see.

Staff costs - We all know that wages are going up in the mainland and, in any case, a higher wage bill was to be expected with the expansion of the shop network. What we have here, however, is a wage bill that has grown three times as fast as revenues, even after a headcount reduction and salary adjustments. More is required, much more.

Administration - The company says it needed more senior management personnel to cope with expansion. What it looks like, however, is just more evidence that economies of scale work the wrong way round here.

Net profit - Down 90 per cent to a mere 15.5 million yuan for a net profit margin of a bare 0.2 per cent and this, by the way, only after booking 41.6 million yuan in one-off gains.

Supplier sponsorship - When the customers are acutely price-sensitive the only way to make some money is to charge suppliers. If you want good shelf space in China Paradise's shops you pay to get it. Supplier sponsorship is now vital to keeping this company going.

Trouble is, however, that suppliers can also shop around for the lowest supply sponsorship charges.

Is this perhaps why the mainland's biggest of these white goods and electronics retail chains, Gome Electrical Appliances, wants to acquire China Paradise?

Dominate the market and you can dictate sponsorship charges again. It could be a dangerous strategy.

Same store sales - The company has more problems than just too rapid an expansion. Not only is the ratio of sales to shop-floor area down, which might be understandable with many new shops, but the existing network is also showing lower sales. This certainly bodes ill.

Standardised, specialty and flagship stores - There has definitely been a very rapid expansion over the last year with the total number of stores in the network up 86 per cent in one year alone, most of them obviously small shops given the much lower growth in overall floor area.

Put it all together and what we seem to have here is a company that has let its growth ambitions run out of control while stress piles up on strain everywhere in its finances despite a boom in mainland consumer spending. The whole edifice stands to crumble if even the smallest thing now goes wrong.

And here comes the big question. In April several major shareholders made a large placement of stock to the investing public.

They must have known at the time how bad their interim accounts might look but I do not recall that the buyers of the stock were warned.

Do our securities regulators have anything about this? I'm waiting, gentlemen. I'm all ears.