1H24 results miss our expectations

Honglu Steel Construction announced its 1H24 results: Revenue fell 6.7% YoY to Rmb10.33bn, attributable net profit dropped 23% YoY to Rmb428mn, and recurring net profit fell 48% to Rmb236mn. In 2Q24, revenue fell 2.6% to Rmb5.9bn, attributable net profit fell 36% to Rmb225mn, and net profit fell 52% to Rmb148mn, missing our expectations due to higher-than-expected R&D expenses.

Core earnings faced pressure from intensifying competition. In 1H24, the firm's steel structure output rose 0.12% YoY to 2.11mnt, selling price per tonne (based on output) fell Rmb300 YoY to Rmb4,743, and gross profit per tonne rose Rmb8 YoY to Rmb418. Expenses per tonne increased Rmb69 YoY (with R&D expense per tonne up Rmb60 YoY), and gross profit per tonne of other businesses fell Rmb43 YoY to Rmb107.Net profit per tonne and core earnings per tonne declined Rmb60 and Rmb97 YoY to Rmb203 and Rmb112.

In 2Q24, gross profit per tonne (GP/t) of steel structures fell Rmb66 YoY to Rmb536, expense per tonne rose Rmb50 YoY to Rmb312, and net profit per tonne and core earnings per tonne dropped Rmb107 and Rmb133 YoY to Rmb189 and Rmb125, down.

New contracts solid; ASP down: Value of new contracts decreased 5% YoY to Rmb14.3bn in 1H24, and dropped 6% YoY to Rmb7.4bn in 2Q24 alone. Contract value of large projects rose 18% YoY to Rmb1.7bn in 2Q24, and the implied processing volume grew 37% to 320,000t (but unit processing fees fell 14%).

Tight cash flow: In 1H24, net operating cash outflow was Rmb45.16mn (vs. inflow Rmb654mn in 1H23), which we attribute to increased payments to suppliers. In 1H24, receivables increased Rmb342mn, inventories grew Rmb259mn, and payables decreased Rmb322mn, with cash-to-revenue ratio rising 2.3ppt YoY to 99%.

Trends to watch

Demand pressure emerging; intelligentization to boost long-term growth. According to the National Bureau of Statistics, investment in high- gross-margin utility facilities in the steel structure sector fell 5% YoY in 7M24, and investment in standardized manufacturing rose 9% YoY. We expect steel structure demand to face mounting pressure amid decline in profits of manufacturing and tight funding for infrastructure construction.

Meanwhile, the firm's stepped-up efforts in intelligentization (R&D expenses rose 63% YoY in 1H24) may drive up short-term costs, but should enhance economies of scale in the long term. We estimate labor costs could be reduced by Rmb40-60/t under a 30% replacement rate). We are upbeat on the firm taking the lead in smart transformation and benefiting from cost reduction.

Financials and valuation

Given rising market pressure and high R&D expenses, we cut our 2024 and 2025 net profit forecasts 24% and 29% to Rmb982mn and Rmb1.05bn. The stock is trading at 8.2x 2024e and 7.6x 2025e P/E. Considering the company's leading position, we maintain OUTPERFORM but cut our target price 28% to Rmb14.5, implying 10x 2024e and 9.5x 2025e P/E, offering 24% upside.

Risks

Weaker-than-expected demand; sharp fluctuations in steel prices; disappointing smart transformation.