1H22 results in line with our expectations
Tiangong International announced its 1H22 results: Revenue grew 2.0% YoY to Rmb2.67bn, and attributable net profit rose 1.6% YoY to Rmb295mn, in line with our expectations. The firm’s 1H22 earnings maintained positive growth despite sluggish domestic demand and rising raw material and fuel prices.
　　Sales volume declined. In 1H22, the firm's overseas sales volume of die steel (DS), high-speed steel (HSS), precision cutting tools, and titanium alloy stood at 81,000t (-2.6% YoY), 10,000t (-6.9% YoY), 120mn units (-18.6% YoY), and 1,900t (+35.2%).
　　Selling prices increased; gross margin fell. In 1H22, unit selling prices of DS, HSS, titanium alloy, and precision cutting tools stood at Rmb17,000 (+25.5% YoY), Rmb51,000 (+33.7% YoY), Rmb85,000 (+15.8% YoY) and Rmb3.6 (+12% YoY). Rising raw material and fuel prices, and weak domestic demand resulted in inefficient cost pass-through in downstream sectors in 1H22. As a result, gross margins of the firm’s DS, HSS, and precision cutting tools were 21.5% (-8.9ppt YoY), 24.3% (-6.3ppt YoY), and 28.5% (+0.4ppt YoY) in 1H22.
　　Operating cash flow under pressure; FX gains increased significantly. The firm’s operating cash flow fell by Rmb548mn to Rmb206mn in 1H22, mainly due to robust growth of its export business and increased inventories and accounts receivable (the firm’s provisions for inventory and credit impairment losses rose 63.1% and 396.6% YoY to Rmb25mn and Rmb19mn in 1H22). FX gains grew by Rmb56mn to Rmb39mn due to the impact of US dollar appreciation.
　　Trends to watch
　　Business resilient despite headwinds; strong product competitiveness. The firm’s exports grew strongly in 1H22. Revenue from exports of DS and HSS products rose 92.5% and 112.0% YoY to Rmb909mn and Rmb313mn, showing the firm’s strong product competitiveness. Amid soaring raw material prices, the firm has continued to pass on cost pressures by raising the prices of its HSS products (with per-tonne gross profit rising Rmb725 YoY). We believe this shows the firm’s strong cost pass-through capability and pricing power.
　　Product mix improved steadily; organic business to drive through-the-cycle growth. In 1H22, sales volume of the firm’s powder metallurgical products surged 135.5% YoY to 358t. The firm has continued to enrich the portfolio of its high-end precision tools. It has also made progress in the development of titanium alloy materials used in the eyeglasses and computer, communication and consumer electronics (3C) industries, which drove up the sales volume, prices, and profit of its titanium alloy products. In addition, the firm’s 7,000t/yr high-speed forging machine project is progressing smoothly. We expect the firm to have 50,000t/yr of production capacity for large-size DS after the project reaches full capacity. As the firm continues to improve its product mix, we expect the increasing sales volume of high-end products to contribute incremental profit to the firm. We are upbeat on the firm’s organic growth despite cyclical fluctuations in the industry.
　　Financials and valuation
　　Due to business restructure, we lower our 2022 and 2023 revenue forecasts 16.3% and 23.5% to Rmb5.52bn and Rmb5.82bn. Considering the rising cost of raw materials, we lower our 2022 and 2023 EPS forecasts 26.1% and 23.9% to Rmb0.25 and Rmb0.33. The stock is trading at 9.0x 2022e and 6.9x 2023e P/E. Given the wide fluctuations in the H-share market recently, we maintain OUTPERFORM and cut our TP 25% to HK$4.21 (14.3x 2022e and 11.0x 2023e P/E), offering 60% upside.
　　Risks
　　Alloy material prices plunge; macroeconomic growth slows.