3Q24 results in line with our expectations

Valin Steel announced its 3Q24 results: Revenue fell 12.3% YoY to Rmb35.72bn and net profit attributable to shareholders fell 71.4% YoY to Rmb440mn, in line with our expectations. 1) Earnings fell slightly due to industry downturn: In 3Q24, ferrous metal prices continued to fall and the price spread between steel purchase and sales narrowed. The firm's gross margin fell 4.0ppt YoY and 1.3ppt QoQ to 6.8%.

2) Expense ratio rose slightly: In 3Q24, the firm's expense ratio rose 0.1ppt YoY and 0.2ppt QoQ to 1.6%, and its financial expense ratio grew 0.18ppt and 0.11ppt QOQ to 0.22%, mainly due to a YoY decline in foreign exchange gains. 3) Cash flow remained resilient: In 3Q24, the firm's operating cash flow was Rmb3,007mn (vs. Rmb184mn and Rmb5,329mn in 1Q24 and 2Q24) and its free cash flow stood at Rmb1,956mn (vs. -Rmb842mn and Rmb4,101mn in 1Q24 and 2Q24), showing its strong ability to obtain cash from operations at cyclical bottoms. 4) Other income increased significantly: In 3Q24, the firm's other income totaled Rmb353mn (vs. Rmb80mn a year earlier), mainly due to increased value-added tax (VAT) credits. 5) Asset-liability ratio rose YoY: In 3Q24, the firm's liability-to-asset ratio rose 7.0ppt YoY and 1.6ppt QoQ to 58.8%, as the firm increased its short- term borrowing reserves by leveraging the low-interest rate for bank loans (balance of short-term borrowings rose Rmb5.18bn YoY to Rmb8.23bn).

Trends to watch Improving product mix to contribute incremental earnings.

1) Galvanized sheet: The firm's subsidiary Hunan Valin Lianyuan Iron & Steel's cold-rolled high-end home appliance sheet project is progressing steadily and is likely to start production in 20251. We expect the firm's galvanized sheet products to improve efficiency and competitiveness. 2) Silicon steel: Demand for non-oriented silicon steel improved QoQ in 3Q24 thanks to rising demand for alternative fuel vehicles (AFV) and home appliances. The firm has reached its target of producing 200,000t of non-oriented silicon steel products per year.

Construction of Phase II of the firm's silicon steel production line (mainly producing high-grade oriented silicon steel) is progressing smoothly, and the firm expects the project to come on stream in 1Q252. We expect downstream demand for high-grade oriented silicon steel to continue improving amid rising power grid investment in China and higher energy consumption standards, which may contribute incremental earnings for the firm.

Controlling shareholder attaches great importance to market cap management; valuation recovery of core assets to accelerate. Inresponse to the Hunan provincial government's call3 for strengthening market-cap management of listed companies and improving investment value, the firm's controlling shareholder increased its stake by 2%4 over July-September, underscoring the actual controller's confidence in the firm's future development and its emphasis on investor returns. We expect the firm to continue to attach greater importance to market cap management. Coupled with the implementation of pro-growth policies since 4Q, we expect market confidence to continue improving, driving up steel prices and earnings. We expect the firm to see a re-rating as an undervalued high-quality core asset.

Financials and valuation

Due to lower-than-expected steel demand from the construction industry chain, we cut our 2024 and 2025 net profit forecasts 18.1% and 5.3% to Rmb2,579mn and Rmb4,060mn. The stock is trading at 12x and 8x 2024e and 2025e P/E. We maintain OUTPERFORM and our TP of Rmb5.01 (13x 2024e and 9x 2025e P/E), offering 10.8% upside, as the firm's improving high-grade steel structure may further enhance its competitiveness.

Risks

Real estate downturn; Disappointing export sales volume of steel products.