The Hour Glass (THG) posted a net profit of S$4.9m (-2.1% yoy) on revenue of S$104.6m (-6.0% yoy) in 1QFY10. Net profit exceeded our expectation, accounting for 27.2% of our full-year estimate. Weaker sales, compared against the same period last year, came as no surprise as consumers cut back on discretionary spending, particularly for items in the luxury segment, as a result of the economic downturn. The bright spot came from the 6.9% qoq growth in revenue, which we believe points to a stabilisation of business conditions. Gross margin fell to 18.3%, a level not seen since 1HFY08, and net margin fell from 6.4% in 4QFY09 to 4.5% (last observed in FY07). Thinner margins were caused by competitors’ destocking exercises driving competition intensity.

Gross margin should start to recover. Although margins contracted yoy and qoq, we expect gross margin to play catch-up in the remaining quarters. We view the sequential growth in revenue as a sure improvement in consumer confidence that can pave the way for margin expansion at the gross profit level. Management has confirmed, on this front, that activity is starting to pick up on the ground.

Adding three new stores in Singapore. THG has added two new boutiques in ION Orchard, and will be adding a third at the Marina Bay Sands integrated resort. As such, higher operating expenses from the opening of these new stores are expected to continue eating away at net earnings. This should surface in the form of higher rental and depreciation expenses. Note that boutique fittings are depreciated over the life of individual leases, which run for an average of three years.

In view of the improvement in consumer confidence, the opening of new boutiques in the prime retail district, and a recovery in margins, we have raised our profit forecasts for FY10-12F by between 23% and 48%.

Maintain HOLD; fair price raised to S$0.70. We continue to value THG at 0.8x P/B, and raise our fair price for the stock to S$0.70 (previously S$0.65). Our new fair price implies an upside of 8% from the last closing price of S$0.65. Maintain HOLD.