Excluding the investment gains and FX change, Lonking’s core net profit in 1H20 dropped ~4% YoY to RMB696mn based on our calculation, due to decline in both revenue and gross margin. The structural weakness of wheel loader demand and market share loss on excavator reconfirmed our bearish stance on Lonking’s long-term competitive power. We took our 2020E-21E core earnings forecasts down by 4-10%, after revising down both revenue and margin assumptions. We trimmed our TP to HK$2.22, based on 7x 2020E core earnings (multiple unchanged). Downgrade to SELL from Hold. We prefer Zoomlion (1157 HK / 000157 CH, BUY) and SANY Heavy (600031 CH, BUY).
- Reported net profit in 2019 was helped by fair value gains. Lonking’s reported net profit increased by 6% YoY to RMB944mn in 1H20. That said, Lonking reported ~RMB242mn net fair value gains on investment, which accounted for 22% of the total segment results (up from 16% in 1H19). We calculate that the core net profit would be down 4% YoY if excluding such gains. This is a weak set of results given the robust demand for construction machinery for the industry as a whole. Meanwhile, the operating cash inflow in 1H20 dropped 52% YoY to RMB407mn, much lower than the reported net profit.
- Lack of revenue growth remains a key concern. Revenue in 1H20 dropped 4% YoY to RMB3.2bn. Revenue from wheel loader sales dropped 4% YoY which is largely within our expectation given the general weakness of wheel loader demand. What’s more negative was the 9% YoY decline in excavator revenue in 1H20, in contrast to the 24% YoY increase in excavator sales volume by the major players in China. We believe Lonking’s excavator business is faced with rising challenges. SANY Heavy, the largest player in the space of excavator, has consistently gaining market share. Meanwhile, Zoomlion, a relatively new player in the excavator market, is rapidly gaining market share.
- Upside risks: (1) recovery of wheel loader and excavator sales; (2) a potential target of acquisition/privatization; (3) Large investment gains.
