Action
Tiangong International has been in the tool steel manufacturing since 1981. It has industry-leading R&D strength, high-quality services, and strong cost control capability. We note several positive changes within the firm, which we think demonstrates Tiangong’s improving competitiveness and experienced leadership. As a result, we expect the firm to grow rapidly moving forward. Its stock prices have fluctuated recently. We think its valuation may be underestimated by the market and will likely recover moving forward.
Reasoning
Breaking foreign firm’s monopoly in the field of high-end special steel; leading R&D capability bolsters organic growth. Tiangong has made new achievements in the field of powder-metallurgy (PM) tap and drill bits, and cutting test results show that its core products are better performing than those imported from Japan and South Korea. We think that the firm is to reap fruits from its PM cutting tools after its powder-metallurgy high-speed steel (PM-HSS) related technology becomes mature. We expect it to be one of the first companies that achieve import substitution. In addition, PM cutting tools will likely become a new revenue growth driver, in our view. Tiangong is increasing investment in R&D in the monopolized high-end special steel market. This demonstrates the firm’s focus on R&D where it outperforms most of its peers in China. We think it is leveraging such advantage to optimize product structure and expand its market share. The firm has realized organic growth by meeting client demand for higher-performance materials and increasing added value of its products.
Strong cost control and quality services enhance competitive advantage. Tiangong focuses on refined management. It cuts power costs by adjusting production schedule, and reduces raw material costs by tracking changes in sales channels and increasing the proportion of return scraps. These are all reflections of the firm’s strong cost control capability. In addition, the firm has established a global sales and service network and works closely with downstream heat treatment solution providers. As a result, the portion of products directly sold to factories continues to increase and it has formed close relationships with multiple clients. In our opinion, strong cost control capability and quality services enhance the firm’s competitiveness and bolster its earnings growth.
Pricing and cost pass-through likely to benefit from solid leadership. Tiangong has been engaged in the field of tool steel for 40 years. Starting as a township enterprise, it now has market share of around 40% and over 10% in domestic and global tool steel markets. We think this proves the firm’s strong competitiveness. Looking forward, we expect it to see stronger competitiveness and more solid leading position, boding well for its pricing and cost pass-through. The firm’s earnings will likely grow solidly, in our view.
Financials and valuation
We keep our 2022 and 2023 EPS forecasts at Rmb0.34 and Rmb0.43. The stock is trading at 8.3x 2022e and 6.6x 2023e P/E. We maintain an OUTPERFORM rating and our target price of HK$5.6, implying 14.1x 2022e and 11.2x 2023e P/E with 70.2% upside.
Risks
Alloy prices plunge; economic growth slowdown is accelerated.