1Q24 results in line with our expectations

Oriental Yuhong Waterproof announced its 1Q24 results: Revenue fell 5% YoY to Rmb7.15bn; attributable net profit fell 10% YoY to Rmb348mn, and recurring net profit fell 4% YoY to Rmb310mn, largely in line with our and market expectations.

Revenue was under pressure due to proactive shrinkage of real estate business. As industry demand remained under pressure (GFA of newly started real estate projects fell 28% YoY and real estate investment fell 10% YoY in 1Q24), the firm's YoY revenue growth slowed to -5% in 1Q24 (vs. 19% in 1Q23 and largely flat with growth in 4Q23), which we believe was mainly due to the firm shrinking its real estate centralized procurement business.

Gross margin recovered slightly as raw material prices fell YoY. In 1Q24, the average price of asphalt edged down 2-3% YoY, and that of emulsions also declined. As a result, the firm's gross margin (before taxes and surcharges) rose 1ppt YoY to 29.7% (+6.7ppt QoQ).

Expense ratio was stable YoY. In 1Q24, the firm's expense ratio rose 1.1ppt YoY to 20.4%. Selling, G&A, and R&D expense ratios rose 0.5ppt, 0.3ppt, and 0.3ppt YoY, mainly due to lower revenue. Overall operating profit margin fell 0.1ppt YoY to 6.9% and net profit margin fell 0.3ppt YoY to 4.9%.

Cash collection remained high; increased receivables and reduced payables led to net cash outflow. In 1Q24, the firm's cash flow-to- revenue ratio fell 6.8ppt YoY to 103%, but its net operating cash flow increased Rmb1.92bn YoY to -Rmb1.8bn (compared with a year ago, cash paid for other operating activities decreased Rmb2.14bn). Receivables increased Rmb1.24bn QoQ (accounts receivable turnover days down 8 days YoY to 128 days). Inventories decreased Rmb332mn QoQ. Other receivables increased Rmb281mn QoQ. Payables and contract liabilities decreased Rmb529mn and Rmb749mn QoQ.

Interest-bearing debt declined; liability-to-asset ratio remained low. In 1Q24, the firm's interest-bearing liabilities declined Rmb1.47bn QoQ to Rmb5.54bn (vs. about Rmb5.19bn of cash on hand). Its liability-to-asset ratio fell 3.6ppt QoQ to 40.3%.

Trends to watch

Rapid adjustment in business structure; retail and engineering channel at the core to support stable valuation. We believe the firm is rapidly reducing its real estate centralized procurement business, and we expect it to achieve steady and high-quality growth through efforts in both the engineering channel and the retail segment, ensuring steady growth in cash flow and profit margin. Looking ahead, we expect the firm to gradually improve its quarterly cash flow by reducing the scale of centralized procurement, prioritizing partners, expanding the engineering channel, and stepping up payment collection. In addition, the firm is accelerating the development of its retail segment to generate high-quality profit and cash flow. We expect the firm to enter a phase of steady revenue growth, improving cash flow, and strengthening bargaining power. We see support for the current valuation.

Financials and valuation

We keep our 2024 and 2025 net profit forecasts unchanged. The stock is trading at 12x 2024e and 10x 2025e P/E. We maintain OUTPERFORM and our target price of Rmb18, implying 16x 2024e and 13x 2025e P/E and offering 39% upside.

Risks

Disappointing demand recovery; sharper-than-expected impairment; slowing growth of retail segment.