1H23 results in line with our expectations

Zhonggu Logistics （Zhonggu） announced 1H23 results: Revenue fell 15.0% YoY to around Rmb6.14bn and attributable net profit reached Rmb890mn （Rmb0.42/sh）， down 42.3% YoY.

In 2Q23, revenue fell 21.1% YoY to Rmb3.11bn （up 2.3% QoQ） and attributable net profit fell 69.6% YoY （up 54.2% QoQ） to Rmb279mn. In 1Q23, the firm generated asset disposal income of Rmb161mn from the sale of ships. Excluding this income, attributable net profit dropped 42.8% QoQ in 2Q23, in line with our expectations.

Transportation volume rose YoY in 1H23; highway transport business performed well; shift from bulk shipping to container shipping paying off. Transport volume rose 14.96% YoY to about 6.66mn TEUs in 1H23. Despite weak demand and falling freight rates, rapid transport volume growth was seen, according to management. Revenue from the waterway transportation business fell 19.1% YoY to Rmb5.03bn and that from the highway transportation business rose 10.18% YoY to Rmb1.11bn. We attribute the growth of the firm's overall transportation volume and highway transportation business to the shift from bulk shipping to container shipping after large vessels came online.

GM fell sharply YoY and QoQ in 2Q23 due to falling freight rates for domestic trade. GM fell 19.4ppt YoY （down 12.6ppt QoQ） to 7.6% in 2Q23. We attribute the decline to falling freight rates in the domestic waterway market （average PDCI index fell 21.5% QoQ in 2Q23）。

Trends to watch

Demand may have bottomed; freight rates to rise in 4Q23 peak season. Costs to improve, GM of domestic trade to recover notably in 2H23. PDCI freight rates have been rebounding since August. We think pent-up demand in 1H23 is emerging. Foreign trade freight rates have stabilized and rebounded recently. Coupled with demand in peak season, this leads us to believe ships for foreign trade are unlikely to return to the domestic trade market in 2H23. We think this lends some support to freight rates in the domestic peak season. In addition, we believe the firm's per-container vessel cost and terminal expenses will continue to decline and GM of the domestic shipping business will rise YoY, as the firm continues to launch large vessels and its freight volume growth declines.

New vessels put into service; to benefit in long term from shift to container shipping from bulk shipping. The proportion of container transport in domestic port cargo throughput was about 20% in 2020, markedly below the average level of over 50% in developed countries. The proportion was even lower for coal transport （low single digits）。

We believe the market share of container transport will continue to increase, as container shipping is an efficient mode of transportation. Zhonggu uses its 18 new large vessels to satisfy demand for container shipping of goods previously transported as bulk cargo. It has put 11 of these new vessels into service. We expect containerization to boost its long-term growth.

Financials and valuation

We maintain our earnings forecasts unchanged. The stock is trading at 9.7x 2023e and 9.1x 2024e P/E. We maintain OUTPERFORM. However, due to falling risk appetite in the market, we cut our target price by 12.6% to Rmb13.58, implying 14.0x 2023e and 13.1x 2024e P/E, offering 44.9% upside.

Risks

Domestic demand weakens; transport capacity shifting from export market to domestic trade market.