2023 results beat our forecast

Kinlong Hardware Products (Kinlong) announced its 2023 results: Revenue rose 2% YoY to Rmb7.8bn, attributable net profit grew 394% YoY to Rmb324mn, and recurring net profit rose 652% YoY to around Rmb289mn. In 4Q23, revenue rose 0.6% YoY to about Rmb2.253bn, attributable net profit grew 193% YoY to over Rmb180mn, and recurring net profit rose 270% YoY to approximately Rmb153mn, beat our forecast due to a higher-than-expected gross margin.

Demand remained tepid and product structure diverged: Revenue

from door and window hardware and door control products rose 1% and 6% YoY to Rmb3.6bn and Rmb410mn in 2023 due to falling demand from the real estate industry and the firm's proactive expansion in new application scenarios (e.g., home furnishing). Revenue from engineering products such as curtain wall structural parts, stainless steel guardrails, and door and window accessories fell 9%, 17% and 4% YoY in 2023 to Rmb396mn, Rmb201mn and Rmb616mn due to a lack of funds. Revenue from home furnishing and other architectural hardware rose 1% and 20% YoY to Rmb1.4bn and Rmb1.1bn, accounting for 32% of the total revenue (up 2ppt YoY).

Growth of businesses in different regions diverged; revenue from

businesses in counties increased: In 2023, the firm's revenue from provincial capitals grew 2%, but that from prefecture-level cities fell 3% YoY. Its revenue from counties grew 10% YoY thanks to its business expansion and product integration.

Gross margin recovered due to falling raw material prices: In 2023,

ASP of aluminum alloy, stainless steel, and zinc alloy (major raw materials) fell 6%, 12%, and 14% YoY. The firm's blended gross margin rose 2ppt YoY to 32.2% (tax and surcharges not excluded, the same below). Specifically, gross margin of door and window hardware grew 3.95ppt YoY, that of other architectural hardware rose 1.8ppt to 19%, and that of home furnishing products fell 1.8ppt to 30% due to the decline in revenue from high-gross-margin HBS.

Expenses remained solid; expense ratio slightly dropped: Selling

expense ratio fell 0.6ppt YoY, and G&A and R&D expense ratio edged up 0.01ppt and 0.01ppt YoY in 2023. The headcount of sales staff dropped 11% YoY to 6,089 at end-2023, boosting per-capita sales by about 5%.

Significant recovery in net margin: Net margin of the firm rose 3.3ppt YoY to 4.15% in 2023 due to higher gross margin, a slight decline in expense ratio, and narrower credit impairment losses.

Strong cash flow: Gross margin and cash flow continued to improve as the firm shifted to orders from small corporate clients. The firm's operation cash flow-to-revenue ratio rose 8.5ppt YoY to 108.3% in 2023. Accounts receivable fell by Rmb505mn YoY, but the firm increased cash payments, resulting in a YoY decline of Rmb661mn in accounts payable. Net operating cash flow dropped 47% YoY to Rmb499mn, implying a net operation cash flow-to-revenue ratio of 154%.

Trends to watch Businesses in counties gradually taking shape; profit to grow after

revenue growth accelerates. Looking ahead, we estimate the proportion of the firm's businesses in counties and overseas businesses has increased to 20% and 10% in 2023. We expect the growth of these businesses to accelerate after the firm completes its transformation and integration of products, driving the firm's revenue growth. We expect the firm to see significant increases in per-capita labor efficiency and profit.

Financials and valuation

Due to weak demand, we lower our 2024 net profit forecast by 10% to Rmb514mn and introduce our 2025 net profit forecast of Rmb669mn. The stock is trading at 24x and 19x 2024e and 2025e. We maintain an OUTPERFORM rating and cut our target price 16% to Rmb46, implying 34x and 26x 2024e and 2025e P/E, offering 19% upside.

Risks

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