Company background: the first tractor mainly manufactures and sells agricultural machinery such as tractors, and produces and sells diesel engines, as well as financial services. The first tractor is a leading supplier of large tractors in China.

We held a non-trading roadshow for the first tractor last week. Management further explained its performance in 2015, industry prospects, growth momentum and development strategy. In 2015, revenue from the first tractor rose 7 per cent year-on-year to 9.6555 billion yuan, but net profit fell 19.3 per cent to 135.3 million yuan. Management stressed that the main earnings data did not reflect the actual improvement in the company's operating performance, as results in 2014 and 2015 were distorted by one-time items and non-cash items. In 2014, the first tractor confirmed a sale gain of 162.3 million yuan, compared with 900000 yuan in 2015. The company also recognized asset impairment losses of 158.3 million yuan and 166.5 million yuan in 2015 and 2014, respectively. Due to the non-deductible nature of some of the losses recorded by the company's subsidiaries, the effective tax rate on the first tractor rose from 22.5% in 2014 to 37.3% in 2015, and the company's gross profit margin increased from 16.8% in 2014 to 18.3% in 2015. mainly due to product structure improvement and cost control.

Management stressed that the government is unlikely to slash subsidies for the purchase of agricultural machinery in the future. Total subsidies are expected to be 23 billion yuan in 2016, up slightly from 22 billion yuan in 2015. The subsidy will cover about 30 per cent of the total price of tractors on average. Management said the government would revise the subsidy scheme and transfer the subsidy to larger, more advanced and more environmentally friendly machines. The subsidy will cover about 20% of the total price of tractors. Management believes that the first tractor will be one of the main beneficiaries of the shift in the subsidy scheme, which is likely to trigger industry consolidation. Manufacturers with limited R & D capacity and weak after-sales service will face more challenges. We expect that the growth of the first tractor in 2016 will be higher than the industry average, mainly due to product upgrades and improved after-sales service. In addition, we believe that the popularity of high-end tractors will eliminate a number of smaller tractor manufacturers, which will give industry leaders such as first tractors the opportunity to benefit from industry consolidation.

Management also said that the company recognized sufficient asset impairment losses between 2013 and 2015. The number of non-cash items should fall sharply in 2016, which is expected to boost the company's net profit. Management also said that Yitou (France)'s net loss in 2015 was as high as 50 million yuan. Long delay (France) has been a drag on the company's operating performance since the merger in 2011. Yituo's losses are expected to narrow in 2016 as the company succeeds in commercializing its automatic shift tractors. In terms of sales, the company's automatic transmission tractors accounted for 10% of total shipments in 2015. Management also said that the first tractor is the only tractor manufacturer in China that has a patent for automatic transmission tractors.

Despite weak operating results over the past few years, first tractor management said the company's medium-and long-term prospects had not changed, mainly because government policies still supported urbanization and industry technology. Due to rising labor costs, agricultural mechanization is an irreversible trend, and the first tractor will benefit most from this trend. In addition, land liberalization and land transfer will also create China's demand for agricultural machinery in the long run. The first tractor is considering expanding its product line to other agricultural machinery and tools. Management said the company could achieve this through an intergroup asset restructuring between its parent company, Yituo Group, and China Machinery Industry Corporation. We can see that the asset restructuring between the China Machinery Industry Corporation has made little progress in the past few years since it became the ultimate parent company of the first tractor. However, the restructuring process may achieve a breakthrough in 2016, mainly due to the government's continued efforts to promote the reform of state-owned enterprises. The company is seeking shareholder approval for H-share buybacks because of the huge price gap between the company's A-shares and H-shares.

Our point of view: between 2013 and 2015, the first tractor is in the investment period, in order to expand the product portfolio and geographical coverage, and upgrade its technology, which puts pressure on the company's profits. In addition, the company's high impairment losses are also a drag on operating results. We agree that the valuation of the first tractor does not seem cheap, but we believe the company has multiple catalysts in the future. We also believe that the company's previous investment will record a return in 2016. We also believe that the company is an investment target for themes such as land reform, rural development and the reform of state-owned enterprises. Although the company's 2015 performance is mediocre, we recommend that investors keep an eye on the stake. The recent poor performance of share prices may provide an opportunity for investors to refocus.

Catalyst: intergroup restructuring with China Machinery Industry Corporation and China Yituo Group; strong results for the first quarter of 2016; asset sales; strong export sales.