Action
　　Powder-metallurgy tool steel (PMTS) is a major type of powder-metallurgy steel. It is premium material used in the high-end manufacturing industry.We believe the PMTS market has a promising outlook, as it has high barriers to entry. Tiangong has focused on tool steel for 40 years, and it was the first Chinese company to break the foreign monopoly in the PMTS market. We think the firm will continue to upgrade its powder metallurgy steel products by leveraging its strong R&D capabilities. We expect Tiangong to further strengthen its competitive advantages in powder- metallurgy steel and believe that PMTS will become its key growth driver.
　　Reasoning
　　Solid outlook for PMTS market driven by rising penetration rate, import substitution
　　Penetration rate of powder-metallurgy steel to increase as manufacturing upgrades require higher-quality basic materials.Tool steel is a high-quality material used in the high-end manufacturing industry, and the adoption of powder-metallurgy technology can considerably improve the performance indicators of tool steel, e.g., stability, resilience, intensity, and abrasion resistance.The penetration rate of powder metallurgy and high-speed steel is only about 3% in China, much lower than the average global level of 10%, suggesting significant upside potential.
　　Attempting to raise penetration rates of China-made products in key value chains; Chinese PMTS market to achieve import　substitution. Aerospace is an important end market for PMTS. China relies almost completely on imports to meet its PMTS demand. We expect import substitution to be achieved due to the cost advantages of domestic firms, as they further upgrade technology and raise penetration rates of China-made products in key value chains.
　　High barriers to entry create a favorable and stable competitive　landscape in the PMTS market. As PMTS accounts for only a small portion of their costs, end-market customers tend to buy high-quality PMTS to ensure their products have stable performance. As such, the PMTS market has high barriers to entry, in terms of technologies and customer requirements. The world’s major PMTS suppliers are mainly　special-steel giants in developed economies. In China, only Tiangong and HEYE Special Steel produce PMTS, and Tiangong is the only firm to have achieved industrialized production of PMTS. The firm may benefit from rising demand for powder-metallurgy steel and a favorable competitive landscape.
　　Tiangong’s powder metallurgy steel business enjoys strong competitive advantages; to become core growth engine. Tiangong　has accumulated expertise in tool steel thanks to its 40-years of experience. It was the first domestic firm to break the technological monopoly of foreign firms in the powder metallurgy steel market.Consequently, the firm gained first-mover advantages. Tiangong’s tool steel division has built industry leading brand power, and established long- term stable relationships with downstream customers. The company has also built strong capabilities in customer services. In our view, Tiangong’s powder metallurgy steel business enjoys strong competitive advantage and could become the firm’s core growth engine.
　　Earnings forecast and valuation We cut our 2021 EPS forecasts 10.5% to Rmb0.24, as cargo backlogs at ports weighed on the firm’s sales volume in 2021. We keep our　2022 EPS forecasts unchanged at Rmb0.34, and introduce our 2023 EPS forecast of Rmb0.43. The stock is trading at 11.8x 2022e and 9.4x 2023e　P/E. Maintain OUTPERFORM. We raise our target price 16.7% to HK$6.30 (implying 16.0x 2022e and 12.7x 2023e P/E) and offering　34.9% upside, given the promising outlook and strong profitability of the firm’s powder-metallurgy products.
　　Risks
　　Sharp volatility in prices of raw material alloy; substantial decline in manufacturing investment.