Lonking’s market share loss on both wheel loader and excavator in 1H19 and management’s conservative post-result comments suggested that the growth outlook is uncertain. We believe Lonking’s earnings has reached a peak. We are incrementally concerned about the outlook of wheel loaders due to the threat of substitution by small-size excavators. We trimmed our 2020E-21E earnings forecasts by 9-10%. While the stock looks attractive at 5x 2019E P/E and 13% dividend yield, we see a lack of catalyst to trigger re-rating in the near term. We reset our TP at HK$1.90, based on 5x 2019E P/E, equivalent to the historical trough valuation. Maintain HOLD.
- Highlight of 1H19 results. Net profit grew 26% YoY to RMB889mn. That said, excluding the fair value gains on investment and other non-recurring items, core net profit dropped 1.7% YoY to RMB727mn based on our estimates. Revenue slightly increased 1.7% YoY to RMB6.76bn. Gross margin was stable YoY at 23.2%, mainly due to higher margin of wheel loader helped by VAT cut which more than offset the margin decline in excavator. SG&A ratio was largely stable. Operating cash inflow reached RMB850mn, up 2.7x YoY.
- Market share loss a concern. Lonking’s wheel loader’s sales volume dropped 2% YoY to 15.4k units in 1H19, versus the industry growth of 1.6% (CCMA figures). We calculated this implied market share of 23.1% in 1H19, down from 24.4% in 2018. Lonking’s excavator sales volume grew 7.5% YoY in 1H19, below the 13% growth for the industry a whole. Management remains conservative regarding the sales outlook, in particular on excavator.
- Distressed valuation but lack of catalyst. Management revealed that it targets to stick with the previous dividend payout policy going forward. Assuming a 64% payout ratio (same as 2018), the stock is trading at ~13% yield presently. Besides, as at end-Jun, Lonking’s net cash and financial investment amounted to RMB4.6bn, which represent >60% of the current market cap. However, with the lack of meaningful earnings growth, it’s unlikely to see re-rating in the near term.
- Upside risks: (1) recovery of wheel loader sales; (2) to become an acquisition target. Downside risks: (1) slowdown of construction activities; (2) substitution risk of wheel loader; (3) investment loss.
