Company profile

As a leading domestic manufacturer of hydraulic components, the Company's primary products include high-pressure cylinders, high-pressure plunger pumps, hydraulic multiple-way valves, hydraulic motors, industrial valves, hydraulic systems, hydraulic test benches, and high-precision hydraulic castings. Hydraulic components and systems serve as core transmission devices for large machinery. The downstream application machinery of the Company's hydraulic products includes walking machinery represented by excavators, underground tunnelling equipment represented by shield machines, marine engineering and maritime machinery represented by ships and port machinery, special vehicles represented by aerial work platforms, as well as industries and fields such as wind and solar power. In terms of the downstream customers, Fortune 500 companies and globally renowned mainframe customers such as Caterpillar, KOBELCO, HITACHI, KUBOTA, SANY, XCMG, Liu Gong, China Railway Engineering, and China Railway Construction Heavy Industry Corporation Limited, are included.

Investment Summary

Steady Revenue Growth in Q3

In the first three quarters of 2024, the Company recorded a revenue of RMB6,936 million, up 9.32% yoy, a net profit attributable to shareholders of the listed company of RMB1,791 million, up 2.16% yoy, and a net profit attributable to parent company excluding non-recurring items of RMB1,735 million, up 2.64% yoy. The gross margin and net profit margin were 41.46%, a yoy increase of 1.27 ppts, and 25.87%, a yoy decrease of 1.81 ppts, respectively. The increase in gross margin was primarily due to the product mix optimization and scale effect. On a closer look, in Q3, the Company recorded a revenue of RMB2,103 million, up 11.12% yoy, a net profit attributable to the parent company of RMB504 million, up 6.07% yoy, and a net profit attributable to the parent company excluding non-recurring items of RMB495 million, up 10.62% yoy. The gross margin and net profit margin were 41.03%, a yoy decrease of 1.93 ppts, and 23.99%, a yoy decrease of 1.13 ppts, respectively. The decrease in gross margin in Q3 was due to the Company's expansion of new business and increased personnel costs. In terms of expenses, the Company's sales and administration expense ratio/financial expense ratio rose by 2.66 ppts yoy and declined by 1.94 ppts yoy, respectively. The increase was mainly due to the expansion of the Company's business layout, the gradual completion of new plants, the increase in the number of employees, and exchange fluctuations.

Industry Lifecycle Recovers from the Bottom

Currently, the construction machinery market is still at the bottom phase. Domestic sales of excavators are showing a recovery trend, while the overseas market for construction machinery is showing a structured trend due to regional variations. According to statistics from the China Construction Machinery Association, 147,381 excavators were sold in China between January and September 2024, down 0.96% yoy. Of these, domestic sales totalled 73,945 units, up 8.62% yoy, while exports totalled 73,436 units, down 9.04% yoy. 181,762 excavators were sold in China between January and November 2024, up 1.93% yoy. Of these, domestic sales totalled 91,231 units, up 10.8% yoy, while exports totalled 90,531 units, down 5.66% yoy. The yoy growth rate of monthly sales volume showed an accelerating recovery trend. The industry has gradually recovered from the bottom of its lifecycle, and demand is expected to steadily increase with the successive implementation of national equipment renewal policies..

By strengthening internal management, adhering to continuous innovation investment, and promoting the business strategy of internationalisation, diversification, and electrification, the Company has the potential for sustained growth while maintaining stable revenue.

Internationalization:

The Company is actively exploring overseas markets, with overseas revenues in H1 2024 growing 15.29% yoy. Meanwhile, the construction of the plant in Mexico is nearing completion, laying a solid foundation for further development in America market. Based on the Company's private placement feasibility report, it is estimated that the Mexico project will generate an annual revenue of RMB1,703 million and a net profit of RMB373 million for the Company upon production.

Diversification:

Sales of the Company's heavy equipment products such as non-standard oil cylinders and non-digging pump valves saw rapid growth, while that of compact hydraulics maintained high-speed growth, further expanding the Company's domestic market share in industries such as aerial work platforms, excavators, loaders, and agricultural machinery. It has also achieved business breakthroughs in overseas markets and achieved bulk supplies.

Electrification:

The Company has prospectively expanded into industrial automation and electrification of construction machinery to build its third growth pole. Currently, the linear drive project is making steady progress, with the main products being electric cylinders and lead screws, which are widely used in precision machining fields such as aerospace, the automobile industry, and optical instruments. Based on the Company's private placement feasibility declaration, it is estimated that the linear drive project will generate an annual revenue of RMB2,096 million and a net profit of RMB498 million for the Company upon production. A larger incremental market is expected to emerge as the humanoid robot industry chain develops. Ball screw products are currently sampled and supplied in small batches..

Investment Thesis

As a leading manufacturer of hydraulic components, the Company expects to remain relatively stable in construction machinery, which will benefit it. In the future, the Company has long-term growth potential as it continues to internationalise, diversify and electrify. We are optimistic about the long-term development of the Company and believe it has the growth potential and barriers to entry to enjoy a premium.As for valuation, we expected diluted EPS of the Company to RMB 1.92/2.32/2.78 of 2024/2025/2026. And we accordingly gave the target price to RMB 60.1, respectively 31/26/21.6x P/E for 2024/2025/2026. "Accumulate" rating. (Closing price as at 24 December)

Risk

Progress of new production line is below expectations

Macroeconomic downturn affects product demand

Sharply rising raw material prices or sharply falling product prices

Financials

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