Key points of investment:

Fenggong Convertible Bonds (123239.SZ):

A+ grade, bond balance 0.62 billion yuan, remaining term 5.16 years. The closing price on November 20 was 120 yuan, with a conversion premium of 19.9%, pure debt premium of 35.67%, and YTM -0.02%.

Original stock: Hengfeng Tools (300488.SZ):

The latest total market value is about 4.1 billion yuan; founded in 1997, it specializes in the production of high-end precision tools. Its products include broaching tools, gear tools, spline measuring tools, etc. Total revenue for 2024.1-3Q was 0.438 billion yuan, +10.65% YoY, and net profit to mother was 96.64 million yuan, +0.08% YoY. The latest PE TTM 30.0x.

Main highlights of Fenggong's debt conversion:

Focus on precision tools for 30 years to create the “teeth” of industrial mother machines. Industrial mother machines are the cornerstone of manufacturing and are directly related to the country's industrial competitiveness and economic security. On November 15, the Ministry of Science and Technology wrote an article in “People's Daily”, once again making it clear that industrial mother engines are “stuck neck” technology that requires effort to break through. Complex tools are the “teeth” of industrial mother machines. Hengfeng has focused on tools for more than 30 years, accounting for 30%-40% of the high-end market for complex tools in China. In 2021, it was recognized by the Ministry of Industry and Information Technology as a “Single Champion Demonstration Enterprise in the Manufacturing Industry”.

Independent research and development, becoming more and more “specialized” in the field of precision tools. The company's products are key components of high-end equipment manufacturing terminals, and technical barriers are high. After years of independent research and development, the company's product unit price and gross margin far surpassed that of peers, and has accumulated a large number of highly sticky customers in automobiles, machinery, and aerospace. Precision broaches are the main product. The company is the only company in China that can manufacture oversized, precise and complex broaches. The “King of Chinese Swords” made a splash in the industry in 2008, and participated in the wing assembly of the first C919 aircraft in 2022.

The operation is conservative and steady, and humanoid robots may bring surprises. The company's revenue has been growing steadily for ten consecutive years. This year's net profit growth rate was low year on year, mainly affected by interest on debt conversion. Fenggong Convertible Bonds were issued in January this year. The balance ratio at the end of the previous year was only 12.89%, and interest expenses soared from 2 million to 25 million per year.

Interest accrued from debt conversion far exceeded actual interest payments. Excluding interest effects, the company's profit increased by about 13% in 2024.1-3Q. The cold extrusion molding tool developed by the company is currently widely used in rolling screw processing, and may be used in humanoid robot roller screw processing in the future.

Double and low balance bonds have a long remaining period and a small debt conversion balance. The absolute price and premium conversion rate of Fenggong bonds are not high, and the equity ratio is strong; the remaining period is long, and the time value of embedded call options is high.

Reasonable valuation derivation for debt conversion

Based on the valuation model of Mountain Securities Convertible Bonds, assuming that the underlying stock price does not change and forcible foreclosures are not taken into account, we believe that the reasonable valuation of Fenggong Convertible Bonds is 123-136 yuan.

Risk warning: insufficient downstream demand; increased competition to a decline in gross margin; risk of repayment of accounts receivable, etc.