Huaxiang's earnings in 1H23 came in line with expectations partly due to the significant improvement and earnings rebound in 2Q23. Against the backdrop of accelerated removal of outdated capacity and given Huaxiang's position as a benchmark in China's casting industry, we are optimistic about its capabilities to extend throughout the value chain, improve the machining capacity, and maintain stable growth based on its three major businesses. In the medium to long term, with sufficient product technology reserves and a solid customer base, Huaxiang is set to vertically extend the product value chain and horizontally expand new growth momentum. We expect its operating revenue and attributable net profit (ANP) to post CAGRs of 9.7% and 26%, respectively, over 2023-25.
We assign 17x 2023E PE, maintain the target price at Rmb15, and reiterate the "BUY" rating.
Earnings came in line in 1H23 with a visible improvement in 2Q23.
In 1H23, Huaxiang posted operating revenue/ANP of Rmb1,535mn/176mn (-12.1%/-2.0% YoY), including operating revenue/ANP of Rmb761mn/77mn (-14.0%/-23.6% YoY) in 1Q23 and Rmb774mn/100mn (-10.1%/+25.3% YoY) in 2Q23. The revenue structure changed in 1H23. Specifically, compressor parts achieved revenue of Rmb812mn (+3.4% YoY) and a gross profit margin (GPM) of 28.8% (up 5.01ppts vs 2022); construction machinery parts achieved revenue of Rmb300mn (-21.8% YoY) and a GPM of 15.9% (down 0.29ppts vs 2022); auto parts achieved revenue of Rmb293mn (+19.2% YoY) and a GPM of 20.4% (down 2.39ppts vs 2022); pig iron and renewables achieved revenue of Rmb70mn (-73.9% YoY) and a GPM of -2.47% (up 2.13ppts vs 2022). The improvement in the GPM of compressor parts and the contraction in low-margin businesses such as pig iron and renewable resources drove the GPM in 1H23 to 23.4% (up 4.56ppts vs 2022). The Company has already taken a large impairment charge on inventory and goodwill in 2022, and the earnings in 1-2Q23 are already on an upward trajectory with the potential to improve sequentially in the remainder of the year.
Vertically extending the product value chain and horizontally expanding new dynamics of growth.
With the commissioning of production facilities funded by the proceeds from its IPO and convertible bond offering, the Company is poised to realize 100% rough machining of compressor parts and continue to improve profitability. In 2022, it further extended its presence along the product processing industry chain and completed the technological breakthrough and market development of the "compressor pump body movement assembly" process. This not only marks a breakthrough from zero to one for the Company in assembly processes, but also positions the Company as the pioneer of the "parts delivery" supply mode in the industry. In 1H23, the Company continued to expand horizontally and successfully entered the washing machine parts supplier system to diversify its product categories. In the auto parts segment, it has also completed small batch delivery and certification of a number of "lightweight material castings". In 2H23, the Company will continue to focus on product development and market expansion. According to company announcement, Huaxiang has established collaborations cooperation with Taiyuan University of Technology and other colleges to initiate the R&D of magnesium-aluminum alloys, titanium alloys, and other material products, deepening the Company's diversified product development strategy.
Controlling shareholder intends to fully subscribe for the private placement, demonstrating confidence in the Company's development.
According to the Company's private placement disclosed on Aug 7, 2023, the Company intends to issue up to 36.63mn shares to its controlling shareholder for Rmb8.19 per share to raise a total amount of no more than Rmb300mn, which will be used entirely for supplementing the working capital and repaying bank loans. The controlling shareholder plans to fully subscribe to the private placement, highlighting confidence in the future development of the Company.
Revenue remains underpinned by the increase in industry concentration and the steady growth in downstream demand.
The global casting market capacity is stable while China's production share continues to improve. As outdated production capacity is gradually phased out through supply-side structural adjustments, we estimate that industry leaders' market share will increase. China's white goods market is in a boom.
According to the National Bureau of Statistics, China's cumulative production of air conditioners amounted to 140,599,000 units (+16.6% YoY) in 1H23. The US National Oceanic and Atmospheric Administration (NOAA) predicts a 50% probability of 2023 becoming the hottest year on record, and the hot weather will drive global air conditioner sales to keep up. We expect that overseas construction machinery sales will maintain a moderate recovery trend.
Off-Highway Research forecast a 2.55% CAGR for global construction machinery sales in regions other than China from 2021 to 2026. China's auto parts industry is growing at a faster rate than the vehicle industry. CAC data show that China's auto parts sales revenue grew from Rmb3.46trn to Rmb4.90trn from 2016 to 2021, with a CAGR of 7.0%. We expect that the Company's revenue will continue to benefit from the increase in industry concentration, as well as stable growth in downstream applications.
Potential risks: Deterioration of the macroeconomic environment; intensified market competition; fluctuations of raw material prices; volatile exchange rate movements; disappointing progress in the implementation of IPO-funded projects; downstream demand growth missing expectations.
Investment strategy: Under the background of accelerated clearing of outdated production capacity, we are optimistic that Huaxiang, as the benchmark in the domestic casting industry, will build an extended presence along the value chain, improve machining capacity and maintain stable growth based on its three major businesses. In the medium to long term, with sufficient product technology reserves and a solid customer base, Huaxiang stands to vertically extend the product value chain and horizontally expand new momentum of growth.
Because the Company's pig iron business has not yet turned around and considering the pressure on its construction machinery parts business in 2023, we revise our 2023E/24E/25E EPS estimates to Rmb0.87/1.05/1.21 (from Rmb0.91/1.08/1.25). We estimate the CAGR of its operating revenue and ANP at 9.7% and 26%, respectively, over 2023-25. Considering the average valuation of 25x 2023E PE per Wind consensus estimates of comparable companies, including Hengrun Heavy Industries (603985.SH),Allied Machinery (605060.SH), Mingzhi Technology (688355.SH), and considering the Company's focus on traditional sectors compared with its comps which are engaged in renewables like wind power and PV, we assign 17x 2023E PE, maintain the target price at Rmb15, and reiterate our "BUY" rating.