1H22 results in line with preannouncement but below our forecast

Eddie Precision Machinery announced its 1H22 results: Revenue declined 37.1% YoY to Rmb1.04bn and attributable net profit dropped 63.7% YoY to Rmb122mn (Rmb0.15/sh), in line with its preannouncement but below our forecast. We attribute this to the impact of COVID-19 resurgence and macroeconomic downturn weighing on the sales volume, and rising raw material prices that eroded profit. In 2Q22, revenue fell 44.0% YoY to Rmb419mn and attributable net profit decreased 64.6% YoY to Rmb50mn.

Revenue from main business declined; gross margin edged down. By contract, in 1H22, revenue from the firm’s excavator breakers and hydraulic components stood at Rmb434mn and Rmb579mn. By segment, revenue from excavator breakers and hydraulic components declined 38.56% and 34.78% YoY in 1H22. The firm’s overall gross margin fell 5.1ppt and 7.2ppt YoY to 30.7% and 29.2% in 1H22 and 2Q22, mainly due to volatile steel material prices increasing cost pressure.

Expense ratios up YoY; profitability down YoY. In 1H22, selling and G&A expense ratios were up 1.0ppt and 1.6ppt YoY to 4.7% and 4.7%, while R&D expense ratio dropped 0.1ppt YoY to 5.0%. The net margin decreased 8.7ppt and 6.9ppt YoY to 11.8% and 11.9% in 1H22 and 2Q22, indicating weaker profitability. Due to lower revenue, the firm’s net operating cash flow decreased Rmb66mn YoY to Rmb86mn in 1H22.

Trends to watch

Demand for excavators under short-term pressure; attachments demand falling. According to National Bureau of Statistics (NBS), China’s fixed asset investment increased 9.3% YoY in 1H22, while investment in real estate development fell 6.4% YoY and construction starts declined 36.1% YoY. As there were fewer buildings under construction in 1H22, sales volume of excavators fell 36% YoY, weighing on demand for excavator breakers. According to the company, about 25-30% of excavators were equipped with breakers in the Chinese market as of end-2020, vs. 30-40% in mature markets. We see potential growth in the penetration rate of excavator breakers in China.

Demand for hydraulic components likely to slow in the short term and resume growth in the medium and long term. The firm has been rapidly expanding hydraulic component capacity since 2020. As a result, the growth and scale of hydraulic component business have exceeded those of excavator breaker business. Currently, a large proportion of excavator breakers in the Chinese market are domestically made, while China’s self-sufficiency in key hydraulic components is less than 50%. Looking ahead, we expect the firm’s market share to increase with technological upgrades.

Financials and valuation

Given falling sales volume of excavators, we lower our 2022 and 2023 EPS forecasts by 18% and 9% to Rmb0.28 and Rmb0.35. The stock is trading at 49x 2023e P/E. We cut our TP by 15% to Rmb19.49 to reflect lower earnings forecasts, implying 55x 2023e P/E, offering 14% upside. Maintain OUTPERFORM.

Risks

Disappointing sales volume of excavators and/or ramp-up of new products such as pump valves.