1Q24 results largely in line with our expectations

Kinlong Hardware Products (Kinlong) announced its 1Q24 results: Revenue rose 1% YoY to Rmb1.37bn, net profit attributable to shareholders grew Rmb10.18mn to -Rmb45.87mn, and recurring net profit rose Rmb1.59mn to -Rmb58.37mn, largely in line with our expectations.

Revenue edged up despite pressure on demand: Despite weak demand from the real estate industry (GFA completed fell 21% YoY in 1Q24), coupled with a lack of market funds and stalled construction of projects, Kinlong transformed its distribution channels and explored counties and overseas markets, leading to a slight 1% YoY increase in 1Q24 revenue. We estimate that revenue from door and window hardware and accessories fell more than 15% YoY due to the downturn in the real estate sector, while revenue from home furnishing and other architectural hardware grew more than 30% YoY.

Raw material prices dropped YoY; gross margin recovered: In 1Q24, ASP of aluminum alloy, stainless steel, and zinc alloy (major raw materials) changed +2%, -17%, and -8% YoY, driving the firm's gross margin up 0.3ppt YoY to 30.4% in 1Q24.

Expense ratio fell slightly: Due to headcount control, overall expense ratio edged down 0.1ppt YoY to 32.2% in 1Q24. Selling expenses fell 5% YoY to Rmb273mn, with selling expense ratio down 1.2ppt YoY. G&A and R&D expenses grew 8% and 11% YoY to Rmb97mn and Rmb65mn, with G&A and R&D expense ratios up 0.4ppt and 0.4ppt YoY.

Cash flow weakened marginally YoY: In 1Q24, the firm's cash flow-to- revenue ratio fell 18ppt YoY to 100%, driving net operating cash flow down Rmb251mn YoY to -Rmb610mn. Accounts receivable dropped Rmb147mn QoQ to Rmb3.58bn (accounts receivable turnover days down 25 days YoY to 230 days), accounts payable decreased Rmb577mn to Rmb2.33bn (accounts payable turnover days down 55 days to 180 days), and inventories fell Rmb92mn to Rmb1.25bn.

Stable gearing ratio: In 1Q24, the firm's liability-to-asset ratio fell 4.5ppt QoQ to 41.2%. Interest-bearing liabilities rose Rmb36mn to Rmb376mn, and cash on hand and wealth management products reached Rmb781mn, indicating that the firm is in a net cash position.

Trends to watch

Businesses in counties gradually taking shape; profit to grow after revenue growth accelerates. In 2024, we think housing completions may gradually decline amid weakening sales, likely to weigh on the firm's revenue from hardware products, dragging its revenue growth. However, we believe the company is increasing investment in counties and overseas markets, and its sales staff is gradually moving away from the real estate industry and focusing more on counties, non-real estate, and overseas markets. In addition, as Kinlong gradually improves the integration of products, we expect the revenue growth to accelerate and contribute most of the incremental revenue for the company. We expect the firm to see an inflection point for a notable increase in per-capita labor efficiency, rapid dilution of expense ratio, and robust profit growth.

Financials and valuation

We keep our earnings forecasts unchanged. The stock is trading at 19.5x 2024e and 15.0x 2025e P/E. We maintain an OUTPERFORM rating, but considering demand pressure, we cut our target price 17% to Rmb38 (implying 23.8x 2024e and 18.3x 2025e P/E), offering 22% upside.

Risks

Weaker-than-expected recovery in demand from completed property projects; improvement in labor efficiency disappoints; expansion into new regions disappoints.