Recently, CADE Engineering (CKHL.US), a construction service provider from Hong Kong, China, submitted its latest prospectus to the US Securities Regulatory Commission (SEC). The company plans to issue 1.7 million shares at a price of $4 to $5 each to raise $8 million. Based on the median value of the proposed issue price range, the market value of Cade Engineering will reach 58 million US dollars.

According to the disclosure, Kade Engineering previously filed a secret statement with the SEC on May 12, 2022. As of March 31, 2022, Cade Engineering has received $2 million in equity and debt investments from investors including CEO Keung Yun Yuen.

According to the news, with the launch of a number of large-scale infrastructures, the Hong Kong government is planning to break through plans to import migrant workers to meet the peak period of the construction industry in order to deal with the shortage of local workers. According to the news, the maximum quota for migrant workers in the construction industry may reach 12,000. The quota will prioritize public works projects above a specific amount threshold, which may give a certain boost to the local construction industry.

However, due to limited growth prospects due to the size of the local market in Hong Kong, and looking at a horizontal comparison, among the Chinese securities that have been listed this year, CapitaTec Engineering also falls into the lower revenue scale and funding amount. There are still many questions about whether the company will be favored by capital after going public.

Earnings almost doubled in a year, and gross margin fluctuated significantly

According to public information, Kade Engineering, founded in 1981, is a one-stop construction service provider focusing on the design, dismantling and construction of new/old buildings, interior and exterior decoration, and overall repair and maintenance projects in Daqing. The company's projects include offices, hotels, schools, industrial buildings and private residential buildings in Hong Kong.

In terms of performance, Cade Engineering's total revenue for fiscal year 2021 (ending March 31, 2021), fiscal year 2022 (ending March 31, 2022), and the six months ending September 30, 2022 was US$32.3951 million, US$607.243 million, and US$3.518 million, respectively; net revenue for the same period was approximately US$3.2902 million, US$3.7694 million, and US$2,2971 million.

Compared to the high growth rate of revenue, the increase in net profit appears to be somewhat “dwarfed.” In the same reporting period, the company's gross margins were 13.59%, 9.80%, and 9.64%, respectively, with large fluctuations.

In terms of financial level, the company's operating cash flows for fiscal year 2021 (ending March 31, 2021), fiscal year 2022 (ending March 31, 2022), and September 30, 2022 were US$1.628,900, US$661,300, and US$1,237 million, respectively. As of September 30, 2022, Capitaat Engineering had $2.3 million in cash and total liabilities of $24.5 million; in the 12 months ending September 30, 2022, the company's free cash flow was $4 million.

High customer concentration during the reporting period may be a cause for concern. In the fiscal year ending March 31, 2022 and March 31, 2021, the company's top five customers accounted for about 85.1% and 85.8% of total revenue; for the six months ending September 30, 2022 and September 30, 2021, they accounted for about 83.7% and 85.6% of the company's total revenue, respectively.

According to information from the Zhitong Finance App, currently, all of the company's business is carried out in Hong Kong. The company's direct customers are mainly Hong Kong real estate developers and general contractors of various real estate development and civil engineering projects. As of March 31, 2022, the company's operating subsidiary had a total of 52 employees in Hong Kong.

Despite the negative impact of the pandemic during the period, Hong Kong's construction industry continued to grow from 2013 to 2021, with a CAGR of 4.12%. While the total value of construction projects of public institutions has declined slightly since the outbreak of the epidemic in 2019, the total value of construction projects of private institutions has steadily rebounded since the outbreak of the epidemic.

As of November 14, 2022, there were 154, 120 and 208 contractors registered under the Hong Kong Buildings Department's Special Contractors Register. The competitive environment is still difficult to say that it is easy to say. In response to this, CapitaTec Engineering also admitted frankly in its prospectus that the competitors facing the company may have an advantage in terms of brand, financing, marketing, and operational history.

As for future development strategies, Capitaat Engineering plans to acquire construction machinery and equipment and integrate robotics technology and automation in construction projects; seek more public agency construction projects on the basis of maintaining its own private institutional customer base.

Hong Kong's construction industry is expected to welcome a new wave of infrastructure

According to information from the Zhitong Finance App, the construction industry is entering a slow recovery stage, fueled by macro trends such as consumption recovery and economic recovery. Data show that in the first half of 2023, the national construction industry signed a new contract amount of 15.44 trillion yuan, an increase of 3.1% over the previous year, which is lower than the GDP growth rate; from the perspective of new project starts, the investment amount for projects started in the first half of the year was 31.94 trillion yuan, down 8.4% from the previous year, reflecting the relatively weak demand for downstream investment in the construction industry.

Specifically, at the level of the Hong Kong construction industry, a number of policies recently introduced will accelerate the recovery of the industry in terms of both the public construction industry and the private construction industry. The Hong Kong construction industry is expected to enter a peak period in the second half of the year.

In terms of utilities, Hong Kong Chief Executive Li Jiachao mentioned in the “Policy Address” issued in October 2022 that Hong Kong should accelerate the development of a number of key infrastructures, including the “three railways+three main roads” of key transportation infrastructure; it will also launch a new “simple public housing”, and build about 30,000 units over the next five years. Other key new development areas include the development plan for Tseung Kwan O's District 137 (expected to provide 50,000 housing units, enter the partnership as early as 2030) and the accelerated reclamation of artificial islands in Chau Chau (expected to be launched in 2025).

In 2023, the Secretary for Development of the Hong Kong Government revealed in an interview that Hong Kong needs to speed up the progress of housing supply and infrastructure construction. In terms of government works projects alone, the annual expenditure will increase from about HK$80 billion to HK$100 billion per year; the building maintenance subsidy scheme is expected to continue. The third round of the “Building Renewal Campaign 2.0” is now accepting applications, and the Urban Development Bureau will provide various financial support and technical support to owners of damaged buildings.

The private sector is expected to be mainly contributed by the commercial construction sector. According to data from the Hong Kong Budget Property Valuation Authority, the number of private offices completed is expected to increase to 275,300 square meters in 2022, while the number of private commercial spaces completed is expected to increase to 173,300 square meters in 2022.

Beginning in 2012, following Central, the Hong Kong government proposed the “Launch Kowloon East” plan to turn Kowloon East into a new generation core business district (CBD). According to official information, the potential supply of office buildings in Kowloon East can reach 5.4 million square meters, which is equivalent to double the number of existing office buildings in Central; since the launch of the plan, the total commercial floor area in Kowloon East has increased by 70%. Currently, it is about 2.9 million square meters, and will further increase to more than 4 million square meters after the completion of planned development projects, including the operations areas in Kowloon Bay and Kwun Tong.

According to information from the Zhitong Finance App, recently, the Hong Kong Construction Industry Council issued the “Construction Project Volume Forecast”, stating that the total construction volume of the Hong Kong construction industry is expected to reach 240 billion to 375 billion yuan per year over the next 10 years. The Construction Industry Council stated that although capital expenditure has remained at around HK$80 billion per year over the past few years, it may continue to grow to over HK$100 billion per year in the next few years; the overall construction volume (including private projects) will increase from about HK$250 billion over the past few years to about HK$300 billion per year.

Worried that the business relies on subcontractors for core competitiveness?

Behind the optimistic overall outlook for the industry, it is worth noting that between fiscal year 2021 (ending March 31, 2021) and fiscal year 2022 (ending March 31, 2022), the company's sales costs increased from US$27.9915 million to US$54.7745 million, up 95.7% year on year, higher than the revenue growth rate during the same period. Meanwhile, during the 2021-2022 fiscal year, subcontracting costs, materials, and tool costs continued to account for more than 90% of total sales costs.

I learned from the prospectus disclosed by Capitaat Engineering that due to the small number of large local contractors and the large number of overseas contractors in Hong Kong, subcontracting is common in the construction industry. Compared to hiring its own workers with many different skills, the company entrusts a third party subcontractor to complete some of the construction projects within the contract, and the company relies on the subcontractor to provide the machinery required for the construction project.

Looking at the revenue structure, the two businesses of foundation and site laying projects and superstructure projects are the pillars of the company's revenue. The total revenue accounts for more than 95%, and the year-on-year increases reached 103.1% and 58.8%, respectively. In FY2022, the share of revenue from foundation and site laying projects increased to 75.7% from 69.9% in the same period last year. However, the Hong Kong foundation industry is limited by the island's geospatial space, and the “ceiling” of the industry is low. In the future, the industry will face a bottleneck of slowing growth, which may have a negative impact on the company's performance.

In the short term, in a situation where the development trend of the industry tends to be optimistic, and benefiting from the low base revenue scale, Kaide Engineering is expected to continue to hand over a growth “report card” in the second half of the year. However, behind the performance figures, where the company's core competitiveness lies, and whether it can stand out in the Red Sea, will be a question that investors consider more.