3Q24 results slightly miss our and market expectations

Honglu Steel Construction announced its 1-3Q24 results: Revenue fell 6.4% YoY to Rmb15.89bn, net profit attributable to shareholders fell 22.2% YoY to Rmb692mn, and recurring net profit fell 49% YoY to Rmb357mn. In 3Q24, revenue fell 5.7% YoY to Rmb5.6bn, attributable net profit fell 32.4% YoY to Rmb228mn, and recurring attributable net profit dropped 51.6% YoY to roughly Rmb121mn, missing our expectations due to a sharp decline in gross profit.

Intensifying competition and pressure on core earnings. In 3Q24, the firm's steel structure output rose 1.4% YoY to 1.14mnt, selling price per tonne (based on output) fell Rmb366 YoY to Rmb4,858, and gross profit per tonne fell Rmb21 YoY to Rmb447. Expenses per tonne fell Rmb41 YoY (with R&D expense per tonne down Rmb44 YoY). Net profit per tonne and core earnings per tonne declined Rmb99 and Rmb116 YoY to Rmb199 and Rmb105.

New contracts remained solid, but unit prices declined. In 1-3Q24, the value of new contracts was Rmb21.9bn, down 4% YoY. In 3Q24, new contracts fell 3.7% YoY to Rmb7.6bn, and the contract value of large projects decreased by 37% YoY to Rmb1.5bn. This implies that the processing volume of large projects dropped 27.5% YoY to 298,000t, with the unit processing fee falling 12.8% YoY to Rmb5,045/t.

The capital chain remains relatively tight. In 1-3Q24, net operating cash inflow was Rmb327mn (compared to a net inflow of Rmb752mn a year earlier). Accounts receivable turnover days increased by 17 days YoY to 51 days, and inventory turnover days rose by 11 days YoY to 164 days. Operating cash flow fell 57% YoY to Rmb327mn in 1-3Q24, while cash flow in 3Q24 was Rmb372mn (compared to Rmb99mn in the same period last year), with the cash-to-revenue ratio declining by 0.51ppt YoY to 98.26% in 1-3Q24.

Trends to watch

Demand pressure is emerging, but smart transformation is likely to boost long-term growth. Looking ahead, we anticipate pressure on factory orders and steel structure demand due to falling profits among industrial enterprises and potential reductions in capex. Intense competition has gradually developed. However, we remain optimistic that the firm will maintain stable orders and output, thanks to its advantages in cost and delivery. Additionally, the firm is increasing its efforts in smart transformation, with R&D expenses rising by 19% YoY in 1-3Q24. While this may weigh on costs in the near term, we expect the firm to accelerate capacity expansion and improve its economies of scale in the long term. Over the next 1-2 years, we believe the firm's capacity utilization rate will increase and its cost advantage will become more pronounced, helping it weather the cycle of demand pressure.

Financials and valuation

We keep our earnings forecasts unchanged. The stock is trading at 10x 2024e and 9.5x 2025e P/E. We maintain an OUTPERFORM rating as market risk appetite improves and the firm is an industry leader, and we raise our target price 17% to Rmb17, implying 12x 2024e and 11x 2025e P/E, implying 18% upside.

Risks

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