The company announced on January 16, 2019 that it will acquire a 29% stake in CP Steel, a non-wholly owned subsidiary, at a price of 14.5 million yuan, and will purchase a production capacity target of 600000 tons from Tangshan capacity Trading Center at a price of 892.4 million yuan. Under the trend of phasing out small-scale production capacity equipment, the company's capacity target acquisition will help to accelerate the landing of large-scale equipment and achieve more sound operation.
Buy back 600000 tons of production capacity target to consolidate the company's capacity base. Zhengda Steel was founded in 2008 by Jinxi Steel and other shareholders, of which Jinxi Steel holds a 71% stake. CP Steel shut down 600000 tons of steelmaking capacity in October 2016 and the remaining 600000 tons in June 2017 to shut down all production equipment. After the completion of this acquisition, Zhengda Iron and Steel will become a wholly-owned subsidiary of the company, and the company will also acquire 600000 tons of steelmaking capacity target from Tangshan capacity Trading Center to consolidate the company's capacity base.
Capacity target acquisition accelerates the landing of capacity replacement program. From the perspective of medium-and long-term stable development, the company is committed to the existing small production capacity equipment to the direction of large-scale development. Since last year, the company has been discussing the capacity replacement plan with the Tangshan municipal government, and plans to replace all blast furnaces with less than 1000 cubic meters and converters with larger blast furnace and converter equipment. Due to the requirements of capacity reduction and replacement, the capacity target of 600000 tons to be acquired this time will be included in the plan of large-scale equipment, which will help to increase the capacity index of the company's new large-scale equipment, and will accelerate the landing of the company's large-scale equipment plan.
On the basis of high profits, production and operation will develop steadily. The company is one of the leading steel enterprises in Tangshan. In 2018, the gross profit margin of H1 sales reached 18.47%. The gross profit of Q3 tons of steel reached 630 yuan. From the 25 Jiapu steel enterprises listed on the market, the company's profitability ranks among the top five. Profitability ranks first among listed steel enterprises in the northern region. On the basis of maintaining high profitability, the development of large-scale equipment will help the company to produce and operate more steadily, and will be less disturbed by policy changes in the future.
Risk factors: industry demand is not up to expectations and production restrictions are not as expected, resulting in lower steel prices; higher than expected rise in raw material costs; trade disputes continue to escalate, and the impact continues to deepen.
Investment advice: since the fourth quarter of last year, the production limit of environmental protection has been lower than expected, and steel prices have fallen sharply. The company's EPS forecast for 2018-20 has been lowered to 1.34 pounds 1.26 pounds 1.25 yuan (corresponding to 1.55 pounds 1.46 pounds 1.45 Hong Kong dollars, the original forecast 1.93 pounds 2.00 pounds 2.10 Hong Kong dollars). We expect the profitability of the industry to remain at a reasonable level this year, and the overall valuation is expected to improve with the continuous optimization of cash flow and debt structure. The current valuation of the company is low and its profitability is strong. With reference to comparable companies such as Minguang, Nanjing Iron and Steel, Songshan Steel and Valin Iron and Steel, we can give the company a valuation of 1.3 times PB in 2019. At the current exchange rate, the target price is HK $8.50, maintaining the "buy" rating.