China's tropical Hainan province is looking to regain its spot in the sunlight. After a topsy-turvy few years, the country's only "duty-free island" hopes to revive travel and shopping-related activity under tighter regulations. S&P Global Ratings thinks official targets on shopping revenue are unlikely to be met, at least not this year.
This is an issue that matters not just for Hainan but also for China and global retailers. The island's duty-free sales hit an annual high of nearly Chinese renminbi (RMB) 50 billion (US$6.8 billion) in 2021 after regulators expanded the personal duty-free allowance for visitors. Rampant "Daigou"--tax-free purchases made for illicit resale elsewhere in China--led authorities to announce tougher penalties and to step up enforcement.
At the same time, Hainan is also designated to become a free-trade port by end-2025, with the aim of attracting global shoppers and business investors.
Where does that leave Hainan now? This is a question we are increasingly hearing from investors. In this piece, we address issues including the impact of Daigou on consumer product names, regulatory headwinds, the implication of a change in free-trade-port status in 2025, and related credit implications.
Frequently Asked Questions
What caused Daigou to take off in Hainan? Will it come back?
We believe the majority of the Daigou impact within Hainan is behind us, given strict regulatory controls in place, particularly from 2023 May.
Hainan became a sourcing area for Daigou after authorities widened the personal allowance for duty-free shopping in June 2020. The policy lifted the duty-free shopping allowance by more than 3x to RMB100,000 (about US$13,800)--the world's highest duty-free allowance. This is available for global visitors as well as those from other parts of China.
Table 1
| Hainan has had the world's biggest duty-free allowance since 2020 | ||||||
|---|---|---|---|---|---|---|
| When first introduced in March 2011 | From July 1, 2020 | |||||
| Annual allowance | RMB30,000 | RMB100,000 | ||||
| Categories covered | 38 | 45 (including tablets, mobile, game consoles, alcohol) | ||||
| Single purchase limit | RMB8,000 | Removed | ||||
| Limit on cosmetics product types | 12 | 30 | ||||
| Source: S&P Global Ratings. | ||||||
By 2022, authorities began cracking down. They set tougher frameworks, encouraged reports of Daigou behavior, and began publicly blacklisting offenders. This worked--but only for a while. Once China lifted movement restrictions, duty-free sales boomed, along with Daigou activity. That led to a second round of stepped-up enforcement, including arrests on the spot. In our view, Daigou activity has stayed repressed since then.
Importantly, the personal allowance for shopping has stayed in place and remains a competitive advantage for the island.
Chart 1
Within the global travel retail category, which type of consumer product was hit hardest by the crackdown on Daigou?
Cosmetics and fragrances, by far. Channel sales fell roughly 35% (see chart 2) once enforcement tightened. Cosmetics typically have the highest weight in the travel-retail mix. For Hainan, it represented 44% of sales mix in the first five months 2023, falling to 41% over the same period 2024 post last year's further tightening.
Chart 2
Case Study: Estee Lauder And The Cosmetics Cooldown
Asia is an important market for Estee Lauder but one that recently lost some of its luster.
The U.S. company says its became the number-one market share leader in the travel prestige-beauty retail in calendar 2018, and the channel rose to over 20% of its total sales in fiscal 2019. The company is heavily invested in Asia-Pacific and built an innovation lab in China and manufacturing facility in Japan to support future growth and streamline its supply chain.
However, in early 2023 the beauty channel began to decline rapidly. Estee Lauder's EBITDA fell by roughly half to US$2 billion, increasing leverage above 3.0x. Poorer performance in China was one of the factors behind our downgrade action late last year.
We lowered the ratings by one-notch to 'A' and have a negative outlook due to the uncertainty around the timeline for normalized channel growth (see "The Estee Lauder Cos. Inc. Downgraded To 'A' From 'A+' On Continued Deterioration; Outlook Negative," published on RatingsDirect on Nov. 28, 2023).
How are the brands and retail channels responding to China's regulatory crackdown? Are they rethinking their commitments?
Brands are launching cost-cutting programs to restore profitability. They are not looking to exit, in our view. Indeed, we expect to see more brands and retailers collaborate to expand both their brand portfolios and retail space.
For example, Estee Lauder is shifting some of its Hainan premises to a new wing at Global Beauty Plaza, a duty-free mall focused on beauty, including via services such as salons and spas (see case-study box below). Estee Lauder's Shanghai Innovation Lab, an research and development facility, is another indicator that company sees long-term potential in the China's market.
Chart 3
Case Study: China Duty Free Group And Global Partners
Late last year, China Duty Free Group (CDFG) opened a new area (Global Beauty Plaza, Block C) in its cdf Sanya International Duty Free City. The Hainan-based facility is the world's biggest duty-free mall and CDFG is the world's largest duty-free operator.
In the new wing, CDFG is partnering with international beauty brands to launch multiple stand-alone boutiques. This includes Estee Lauder as well as Coty (BB-/Positive/--), a distributor of multiple brands including Gucci, Burberry, and Chloe brands.
In its recent earnings call in May 2024, Coty noted that its China arm is growing sales at double digits, including triple digit growth in Hainan (see "Coty Inc. Upgraded To 'BB' From 'BB-'; Outlook Positive; Debt Rating Raised," Sept. 29, 2023).
Is there more downside to come in Hainan? When will we see recovery?
Yes, we expect more downside, though not all related to the tightening rules on Daigou. Now that borders have reopened, Hainan has to compete with destinations elsewhere in Asia and the globe. Plus consumer confidence in general is low in China. Hainan is off to a weak start, with duty-free sales down 29% year on year from January to May. Officials are eyeing a 10% increase in shopping revenue this year, which we believe is unlikely to happen.
It could take at least three years for Hainan to surpass its peak sales in 2021. China consumer confidence has been low for two years and the pace of recovery will likely be very gradual, given the negative wealth effect of weaker property and stock markets.
Hainan's duty-free spending per head peaked in 2022 at RMB8,041 (about US$1,130) and dipped to RMB5,424 (about US$750) in the first five months of this year. By our forecasts, full-year spending per head will stabilize toward RMB5,000-RMB5,300 per head. This is given the year-on-year comparison for Daigou impact should be behind us after May 2024, with spending per head likely dipping 10%-15% for the rest of the year.
Chart 4
How will the free trade port status change travel retail in Hainan?
This is still not clear. While the island will become a free-trade port by end-2025, the details on the program are not yet available. Presumably, this status will confer tax breaks and visas to global investors, along with other incentives. But we don't know which, if any, areas will be targeted, or the magnitude of the incentives. Nor do we know when such details will be announced.
That said, we do see potential benefits for duty-free operators; for example, a possible expansion of categories to be included for duty-free purchases. Global brands may find more direct retailing opportunities (as opposed to selling through duty-free operators). The pricing and profit structure could also change based on tax schemes offered.
Despite these unknowns, we expect the island's attractions for shoppers to grow. This is given the strong development pipeline brands and retailers (see table 2), on top of the existing 12 duty-free shops covering 500,000 square meters.
Table 2
| Major retail developments are still growing in Hainan | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Operator | Property | City | Opening/ planned opening | Construction area ('000 square meters) | Notable features | |||||||
| China Tourism Group Duty Free Corp. Ltd. | Haikou International Duty Free City | Haikou | 2022 | 289 | Tax-free business, high-end offices, high-end hotel, art and tourism spaces. 280k sqm devoted to duty-free retail | |||||||
| China Tourism Group Duty Free Corp. Ltd. and Swire Properties Ltd. | Sanya Yunjie Island (Duty Paid) Project | Sanya | 2020 | 34 | Duty paid retail.connect to Sanya International Duty Free City | |||||||
| China Tourism Group Duty Free Corp. Ltd. and Swire Properties Ltd. | Sanya Taikoo project | Sanya | 2025 | 368 | Resort-style, premium retail duty paid project in Haitang Bay | |||||||
| DFS Group and Shenya Group | Yalong Bay project | Sanya | 2026 | 128 | Luxury retail and entertainment destination, with more than 1,000 luxury brands likely | |||||||
| Zhuhai Duty Free Enterprises Group and Avolta AG | Sanya Bay One project | Sanya | 2025 | 160 | Duty paid retail-plus complex | |||||||
| Wangfujing Duty Free | Wangfujing International Duty Free Harbor City | Wanning | 2023 | 103 | Duty free and duty paid retail. Hainan's first drive-in cinema and a skating rink | |||||||
| sqm--Square meters. Source: Company disclosures, government announcements, S&P Global Ratings. | ||||||||||||
Related Research
- China Retail Sales Will Likely Grow Slower Than GDP This Year, Jan. 23, 2024
- Industry Credit Outlook 2024: Retail and Restaurants, Jan. 10, 2024
- Industry Credit Outlook 2024: Consumer Products, Jan. 9, 2024
This report does not constitute a rating action.
| Primary Credit Analysts: | Sandy Lim, CFA, Hong Kong 2533 3544; sandy.lim@spglobal.com |
| Amanda C O'Neill, New York + (212) 438-5450; amanda.oneill@spglobal.com | |
| Secondary Contacts: | Manqi Xie, CFA, Hong Kong 852-2532-8001; manqi.xie@spglobal.com |
| Rocco A Semerano, Milan + 44 20 7176 3650; rocco.semerano@spglobal.com | |
| Research Assistant: | Victor Kong, Hong Kong |
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