1H24 results miss our expectations

Valin Steel announced its 1H24 results: Revenue fell 4.5% YoY to Rmb75.95bn. Net profit attributable to shareholders dropped by 48.2% YoY to Rmb1.33bn. Earnings missed our expectations, as the recovery of demand was tepid in 1H24.

Proportion of special steel continued to rise; overseas sales volume hit a new high. In 1H24, the company's steel sales volume dropped by 6% YoY to 12.7mnt, of which 64.6% were special steel. Sales volume of special steel as a percentage of total steel sales volume increased by 1.2ppt in 1H24. In 2Q24, overseas sales volume jumped 38% YoY to 0.53mnt. All the steel sold in overseas markets were high-value-added products.

Earnings improved marginally, as demand recovered. In 1H24, the company's earnings were under pressure, as demand did not recover notably and raw material prices remained high. The price per tonne of steel dropped by 3.4% YoY to Rmb4,407 and the gross profit per tonne of steel dropped by 32.3% to Rmb 355. In 2Q24, the company's earnings improved marginally, as demand recovered. GM rose 2.3ppt QoQ to 8.5% (-3.1ppt YoY).

Period expense ratio remained stable. The company increased cost control. In 2Q24, selling and G&A expenses declined by 6% and 7% YoY. In 1H24, expenses per tonne of steel remained stable at Rmb4,052.

Investment income and other income increased substantially. The firm's investment income and other income rose Rmb70mn and Rmb1.05bn YoY in 1H24, due to interest from large-denomination certificates of deposit (CDs) and increased value-added tax (VAT) deductions at subsidiaries.

Trends to watch

Potential of organic growth notable; product advantages to improve. The company continues to add new types of special steel products and improve its competitive advantages in products.

Silicon steel: In 1H24, the company developed 30 new grades of products. Sales volume rose 46% YoY to 0.99mnt. The construction of the Phase II silicon steel project accelerated. The company expects this project to start production in early 2025.

Automotive sheets: The Phase II project and the patented product certification proceeded smoothly. The company expects this project to operate at the design capacity by end-2024.

Industrial bars and wire rods: The proportion of special steel in total sales volume increased steadily. We expect the percentage of special steel to increase by 5-10ppt to 25-30% in 2025.

We are upbeat on the organic growth of the company, given the increased proportion of high-end products in its product portfolio and its notable product advantages.

Healthy cash flows; average valuation to increase in the medium term. The company maintains solid earnings and sound business operations despite the cyclical downturn in the steel industry. In 2Q24, its net operating cash flow and free cash flow rose Rmb5.1bn and Rmb4.9bn YoY to Rmb5.3bn and Rmb4.1bn. In addition, the company continues to increase cash dividend payments. Its dividend payout ratio exceeded 30% in 2023. We think the company will continue to maintain healthy cash flows, as its capex declines and downstream demand recovers. We expect its average valuation to increase in the medium term.

Financials and valuation

We cut our attributable net profit forecast 44.5% to Rmb3.15bn for 2024 and 38.7% to Rmb4.29bn for 2025, as the decline of gross profit per tonne of steel in 1H24 was sharper than expected. The stock is trading at 8.7x 2024e and 6.4x 2025e P/E. We maintain an OUTPERFORM rating, given the firm's healthy cash flows. We cut our target price 34.1% to Rmb5.01 to reflect a low sector valuation. Our TP implies 11.0x 2024e and 8.1x 2025e P/E, offering 25.9% upside.

Risks

Real estate sector weakens more sharply than expected; global economic downturn deteriorates.