1H22 earnings miss our expectation

Traffic Control Technology announced 1H22 results: Revenue fell 10.4%YoY to Rmb936mn and net profit attributable to shareholders declined 23.4% YoY to Rmb81mn （implying EPS of Rmb0.44）， missing our expectation, mainly due to the COVID-19 pandemic and macroeconomic downturn. In 2Q22, the company's revenue fell 19.5% YoY to Rmb547mn; the company’s net profit attributable to shareholders declined 27.3% YoY to Rmb59mn.

Gross profit margin rising but net profit margin falling YoY. In 1H22, the company's gross profit margin rose 4.4ppt YoY to 37.3%, mainly due to a rising proportion of new products. The company’s selling expense ratio and G amp;A expense ratio increased by 0.6ppt and 2.1ppt YoY to 2.6% and 12.5% in 1H22, and it increased R amp;D investment with R amp;D expense ratio growing 3.4ppt YoY to 12.6%. Due to increases in expense ratios, the company’s net profit margin fell 1.5ppt YoY to 8.7% in 1H22.

Inventories well managed but operating cash flow relatively weak.At the end of the 1H22, the company's inventories decreased by Rmb164mn compared with the beginning of 1H22 to Rmb702mn, mainly due to a decline in product shipments. The company’s operating cash flow reported a net cash outflow of Rmb169mn in 1H22 （vs. a net inflow of Rmb7.14mn in 1H21）， mainly due to a decrease in payables and an increase in funds used in operations.

Trends to watch

We expect the 14th Five-year Plan period to herald a peak period for urban rail construction, but growth of newly-built urban rail projects to slow afterwards. About 1,200km of urban rail projects were completed in 2020 and 2021 in China, a record. However, due to factors including the COVID-19 pandemic, the length of newly-started urban rail projects fell to less than 1,000km nationwide, and the length of urban rail projects under construction fell from 6,903km in 2020. We estimate the length of urban rail projects under construction at less than 6,000km this year. The length of China’s subways in operation accounted for about 60% of the global total. In recent years, changes in local governments’ funding and approval for subway projects have imposed constraints on the construction of domestic new subway projects. We expect the growth of newly-built urban rail projects to slow and the aftermarket for repair, maintenance, and operations of urban rail projects to expand.

New orders recovering compared with 2021. According to the semi-annual report, the company won bids for Rmb1.996bn of orders in the first seven months of 2022 （already exceeding that in full-year 2021） and it signed Rmb1.353bn worth of contracts in the first six months of 2022. As of the end of 1H22, the company’s orders on hand totaled Rmb5.432bn （excluding taxes and Rmb1.731bn of newly-won orders whose contracts have not been signed）。

Financials and valuation

Given the COVID-19 pandemic’s impacts on deliveries of projects, we lower our 2022 and 2023 EPS forecasts by 14% and 18% to Rmb1.40 and Rmb1.42. The stock is trading at 15.1x 2022e and 14.9x 2023e P/E. As we revise down earnings forecasts, we cut our target price by 20% to Rmb26 （18.6x 2022e and 18.4x 2023e P/E）， offering 23.5% upside. We maintain OUTPERFORM rating.

Risks

Disappointing tenders for projects in downstream industries; COVID-19 weighing on deliveries of projects.