Abstract: After achieving strong results in 2017, Xiwang Special Steel previously announced earnings for the first quarter of 2018. Net profit for the first quarter is expected to increase 26% year-on-year, mainly benefiting from improvements in industry supply and demand. As the government plans to further eliminate 30 million tons of excess steel production capacity in 2018, we believe steel prices will be relatively strong and support the company's moderate gross profit and profit growth in 2018. The company plans to gradually increase the revenue contribution of special steel from 30% to 70%, which will also help the company achieve a sustainable and stable gross profit margin over the long term. Xiwang Special Steel's current price-earnings ratio in 2018 is 2.5 times, which is 52%/67% compared to Ma Gang/Angang Steel's discount.
Given the company's improved profits, the resumption of dividend payments, and increased market interest in the company, we think there is still room for this discount to be narrowed. If the market's concerns about its parent company's financial situation are completely alleviated in July, it will become an important stock price catalyst for Xiwang Special Steel.
The momentum is improving in the first season. The company expects net profit to increase 26% year-on-year in the first quarter of 2018. This is mainly due to: (1) a decline in steel supply, as the government promotes favorable policies to ban medium frequency furnaces and the removal of production capacity in the steel industry, and the shutdown of some enterprises that do not meet environmental standards; (2) rising demand for steel, as the government approves a large number of infrastructure projects; (3) reduced financing costs, and reduced tax expenses because a subsidiary was recognized as a high-tech enterprise. We believe this success reflects the company's ability to continue its profit growth from 2017 to 2018 with its strong position in the industry in Shandong.
Benefiting from improved supply-demand balance and product portfolio optimization, gross margin is expected to continue to rise in FY18. Management expects the company's gross gross profit per ton to rise further to 650-700 yuan (2017:647 yuan) in 2018, mainly due to positive government policies (such as plans to further eliminate 30 million tons of excess steel production capacity in 2018), which will continue to alleviate the overcapacity problem in the steel industry. This helps improve the balance between supply and demand and raise the average selling price of the industry, and also benefits some large steel companies and steel companies with a high regional share, including Xiwang Special Steel. Furthermore, it is expected that off-peak production in the steel industry will further put pressure on some small steel companies, which will eventually help Xiwang Special Steel increase its market share and bargaining power.
The company aims to achieve a consistent and stable gross profit margin by optimizing the product portfolio. In 2017, Pu Steel/Special Steel contributed 70%/30% to Xiwang Special Steel's revenue. The company plans to adjust the above ratio to 30%/70% by increasing the contribution of special steel within three years, because management believes that the high gross margin of special steel products is more sustainable (16.3% in 2017), and demand for special steel in wind power and other industries is also relatively stable. Regarding Pugang, management pointed out that its price and gross margin are quite volatile, and at the same time they are cautious about the sustainability of Pu Steel's high gross margin.
Production capacity is expected to expand in 2018, and utilization rates will also increase. Management expects production capacity to increase by 300,000 tons in 2018, which will bring the total production capacity to 3.3 million tons. The new production capacity will be mainly for steel rails (which are special steel). Taking into account the new production capacity, management expects the company's capacity utilization rate to rise to 110% by the end of 2018 (end of 2017:100%).
There are several factors that support orders in 2018 and beyond. The company sees stable demand for steel for infrastructure projects in Shandong (such as the Jiqing High Speed Rail), and will support the company's orders over the next 2-3 years. The company is also expected to benefit from the development of Xiong'an New Area, as the company has business in Hebei. Furthermore, management pointed out that the company began supplying axle billets to CRRC's subsidiary earlier this year. Management said that the current supply of axle billets to CRRC subsidiaries is still in small batches, and is expected to gradually increase in the future.
Enjoy tax benefits in 2017-2019. Xiwang Metal Technology, a subsidiary of the company, obtained a high-tech enterprise certificate from a government agency in December 2017. The validity period is three years. During this period, the subsidiary is eligible for a preferential corporate income tax rate of 15%. With this tax benefit, Xiwang Special Steel saved a total of about RMB 810,000 in income tax expenses in fiscal year 17.