Company Update. China Oriental Group (581 HK) Rating: Buy; TP: HK$8.4. HK equity market China Materials Steel. 04 Sep Reverse NDR Takeaways

Transcription

1 Company Update HK equity market China Materials Steel China Oriental Group (581 HK) Reverse NDR Takeaways Last week, we hosted a reverse NDR with China Oriental Group (COG) in Shanghai, which was generally well received by investors after a thorough understanding of the company's financial position and profitability. In general, investors said that they had just noticed the name in recent months, which was mainly due to company s less proactive contact with investors when the company was being suspended. Few people noticed the fact that COG is one of the most outstanding players in steel industry, resulting in the undervaluation. After the company's recent entry into Southbound Trading of Shanghai-Hong Kong Stock Connect, we believe the mainland investor's preference for high quality private enterprises will help narrow the valuation gap between COG and Magang and Angang in HK market. Although COG s share price showed performed well recently, we see the share price has plenty of upside backed by lots of catalysts including: 1) valuation rerating from industry s sustainable profitability; 2) 3Q industry profit is going to remain robust, some A-share peers have foreshowed 3Q net profit would surpass 1H, and we estimated 3Q net profit of COG may exceed RMB1.5bn; 3) COG has been selected into HSSI and Shanghai-Hong Kong Stock Connect list, it is expected to attract more mainland investors attention and capital inflows which is likely to result in a higher valuation; 4) COG has a net cash position at present and it is highly likely to maintain afterwards, we believe its financial situation is one of the best companies in the industry. Our latest FY17/18 revenue and net profit forecasts is RMB 43.61/45.54bn, up 65.0/4.4% yoy compared to FY16/17, and RMB 4.56/3.56bn, up 532.1/-22.0% yoy. EPS is expected to reach RMB 1.293/0.961, and NAV to RMB 13.68/15.66bn. We value COG with PB-ROE model, and narrow the valuation gap in our model between COG and Magang and Angang from 30% discount to zero, in order to reflect the preference of mainland investors for high-quality private companies. We trim up the target PBR to 1.67x, raise our TP to HKD 8.4, and maintain Buy rating. Our TP is equivalent to 5.4/7.4x FY17/18 PER and 1.84/1.67x PBR. 04 Sep 2017 Rating: Buy; TP: HK$8.4 Basic Information (Updated to 4/9/2017) Share Price 5.91 (HK$) Market Cap (HK$ bn) Free Float (%) 25.03% Shares in issue 3, (mn share) 52 weeks high/low (HK$) 3 Months Average Daily Turnover Major shareholder Source: Bloomberg Share Price & Turnover Trend Mr. Han Jingyuan ArcelorMittal (HK$ mn) 35.8% 39.2% Fig1:COG (581 HK) Financial Summary (Rmb Mn) F 2018F 1H16 1H17 Yoy (%) Revenue 21, , , , , , % - Cost of Sales (20,714.7) (23,753.5) (36,623.6) (39,890.2) (10,075.9) (17,401.6) 72.7% Gross profit , , , , , % - Selling and distribution expenses (100.8) (118.6) (117.1) (120.9) (58.7) (60.0) 2.3% - Administrative expenses* (287.0) (550.6) (620.9) (691.3) (247.3) (310.5) 25.6% Operating profit (467.1) 1, , , , % Profit before taxation (889.7) 1, , , , % - Income tax (46.3) (523.9) (1,584.9) (1,236.4) (262.8) (635.1) 141.6% NPAT (766.5) , , , % Basic EPS (RMB) (0.261) % DPS (HKD) N/A Source: Bloomberg Analyst Endy Lo Endy.lo@ztsc.com.hk Source: Company data,, * stripping out one-off items Tel: (852) Fax: (852) P.1

2 Key Takeaways 1) Production limitation in heating season (Oct 15 March 15) As COG's main capacity is located in Qanxi County, Tangshan (about 10mn tons), production limitation will pose an impact on the company. It will take 1 month to restart the blast furnace later. Production limitation is expected to be calculated by 50% capacity of blast furnace. If the production limitation policy is realized, the company will purchase billet in advance. Since the current policy only released the framework and without any specific contents, the impacts on COG is still unknown. Specific details of the policy will be announced at the end of September, which is expected to be more stringent in execution this time. The company said that Jinxi Steel is currently supplying 100% heating to Qanxi County by making use of industrial waste heat. There are no other enterprises supplying heating in Qianxi County. To guarantee 100% supply of heating, COG has to maintain 70-80% capacity utilization. We believe the production limitation in this heating season will not take a sweeping approach. Instead, the production of good enterprises and enterprises that involve in people's livelihood should be reduced as least as possible. Enterprises that fail to meet the environmental protection standard should be required to limit or suspend the production. We believe COG has already met the environmental standard and performs better than industry average. As its business involves heat supplying for the people, we believe the level of output cut for COG will be far lower than its peers. Whereas, we believe the company is likely to benefit from production limitation and the impact by its output cut can be offset by higher ASP. We estimated that RMB200/tons or 5% price hike is enough to offset the cut and cover the loss. 2) Productivity The current capacity is around 11mn tons, and 1H17 sales is around 6.16mn tons. Utilization rate has already surpassed 100% in 1H17. There is limited room to further increase production. The company believe its peers had also increased their production in 1H due to industry prosperity and the current supply is tight in the industry. Due to the high industry profitability in 2017, COG has not conducted any maintenance to blast furnace. At present, 7.5 mn tons of Jinxi Steel production is for section steel and strip steel while 2.5mn tons is mainly for rebar. 1mn tons of capacity in Tianjin is rented at RMB 4mn per month. Meanwhile, COG lent RMB 400mn to them at 12% annual interest rate. The lease will expire at the end of this year, and renewal is now negotiating. 1H profit was around RMB100mn. Foshan factory is mainly responsible for galvanized sheet processing. The current capacity is around 1,100 tons, with 10% upper buffer but now is closing to the upper limit. Government policy prohibits additional production, but only allows for replacement. 1mn tons of ultra-large type of section steels and steel sheet piles will put into operation in 4Q17, which is capacity replacement instead of new capacity. Its gross profit is higher than the current products. Around RMB1-1.5bn of capital expenditure is paid by internal fund, without any share placing. 3) Sales Current 3Q order is full. 90% of product sells to distributors, another 10% is direct sales. The profit margin of direct sales is few points higher. Direct sales ratio is expected to increase in the future, but it would be harder to reach. Products are mainly sold in regions within 300 kilometers. Tel: (852) Fax: (852) P.2

3 4) Cost The company do not see any large-scale provisions and impairment in 2H17. Lower cost than Magang and Angang is mainly due to: 1) lower labor cost; 2) higher capacity utilization; 3) lower financial cost (net cash position now) 1H17 self-generated electricity ratio was 63% in1h and estimated maximum ratio can reach 80% in the future. Other 37% of purchased electricity accounted for 3% of the total cost. Steel crap currently accounts for 5% of proportion, vs. 3% in The lower ratio is mainly due to consideration on quality and labor cost saving. Current production cost of electric arc furnace is RMB300/ton higher than blast furnace. 5) Others Inventory: the steel mill is near Caofeidian port. Iron ore and coking coal inventory are generally held for 1-2 weeks. Iron ore is mainly imported from Australia. Finished goods inventory takes no more than 1 month to sell to avoid price risk. No less than 20% dividend payout ratio. In addition to the investment of 1mn tons capacity replacement, there is no other substantial capital expenditures at present, and the company is considering how to use the cash on hand. As environmental standards keeps stricter every year, about RMB mn of capital expenditure is allocated on environmental protection facilities. Tel: (852) Fax: (852) P.3

4 Historical Ratings & Target Price China Oriental Group (581 HK) share price performance & rating Source: Bloomberg, Date Closing Price Rating Change Target Price 1 19/06/2016 HK$2.24 No rating Non-rating 2 28/07/2016 HK$3.96 Buy (Initiation coverage) HK$ /08/2017 HK$5.03 Buy (Unchanged) HK$ /09/2017 HK$6.04 Buy (Unchanged) HK$8.2 Remark: The share price has been adjusted for dividend, stock merge and split. Tel: (852) Fax: (852) P.4

5 Rating Definitions Rating Definitions for Company: Benchmark potential returns within 6 months after the report date over HSI m/m price change Buy: Potential returns expected to outperform benchmark by more than 20% Accumulate: Potential returns expected to outperform benchmark by more than 5% but less than 20% Neutral: Expected stock relative performance ranges between -10% and 5% Sell: Potential returns expected to underperform benchmark by more than 10% Rating Definitions for Sector: Benchmark company stock change within 6 months after the report date over HSI m/m price change Positive: Neutral: Cautious: Sector expected to outperform benchmark Sector expected to follow benchmark Sector expected to underperform benchmark Tel: (852) Fax: (852) P.5

6 Disclaimer This report has been prepared by Zhongtai International Securities Limited ( Zhongtai International ). This report is for distribution only under such circumstances as may be permitted by applicable law. Nothing in this report constitutes a representation that any investment strategy or recommendation contained herein is suitable or appropriate to a recipient s individual circumstances or otherwise constitutes a personal recommendation. It is published solely for information purposes, it does not constitute an advertisement and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments in any jurisdiction. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, except with respect to information concerning Zhongtai International, its subsidiaries and affiliates, nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in the report. Zhongtai International does not undertake that investors will obtain profits, nor will it share with investors any investment profits nor accept any liability for any investment losses. Investments involve risks and investors should exercise prudence in making their investment decisions. The report should not be regarded by recipients as a substitute for the exercise of their own judgment. Where necessary, the recipients should obtain professional advice before making investment decisions. Past performance is not necessarily a guide to future performance. The value of any investment or income may go down as well as up and you may not get back the full amount invested. Any opinions expressed in this report are subject to change without notice and may differ or be contrary to opinions expressed by other business areas or groups of Zhongtai International as a result of using different assumptions and criteria. Research will initiate, update and cease coverage solely at the discretion of Zhongtai International. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. The analyst(s) responsible for the preparation of this report may interact with trading desk personnel, sales personnel and other constituencies for the purpose of gathering, synthesizing and interpreting market information. Zhongtai International is under no obligation to update or keep current the information contained herein. This research report has been translated from the original Chinese version. If there is any inconsistency or ambiguity between the English version and the Chinese version, the Chinese version shall prevail. Disclosure of Interests: (1)Zhongtai International and/or its affiliated or associated companies did not have any investment banking relationships with the companies mentioned in this research report in the past 12 months. (2)All of the views expressed in this research report accurately reflect the independent views of the analyst(s). Neither the analyst(s) preparing this report nor his/her associate(s) serves as an officer of the companies mentioned in this report, or has any financial interests in or holds any shares of the securities mentioned in this report. (3)Zhongtai International and/or its affiliated or associated companies may hold more than 1% of shares of the securities mentioned in this research report. Zhongtai International Securities Limited Without the prior written consent obtained from Zhongtai International, any part of the materials contained herein should not (i) in any forms be copied or reproduced or (ii) be re-disseminated. Tel: (852) Fax: (852) P.6