2024 earnings miss our expectation

Honglu Steel Construction announced its 2024 results: Revenue fell 8.6% YoY to Rmb21,514mn, and net profit attributable to shareholders dropped 34.51% YoY to Rmb772mn. In 4Q24, the firm’s revenue fell 14.4% YoY to Rmb5,627mn and net profit attributable to shareholders declined 59.7% YoY to Rmb117mn. The firm’s 2024 earnings miss our expectation due to lower-than-expected gross margin and impact from credit and asset impairment losses.

Production and sales volumes grew slightly: In 2024, the firm's full- year production volume and sales volume rose 0.5% and 1.8% YoY to 4.51mnt and 4.33mnt, and its full-year capacity utilization rate was 88.4% (-3.1ppt YoY). In 4Q24, the firm’s production volume was 1.14mnt (-8.8% YoY and flat QoQ).

Gross profit declined due to fiercer competition: Based on our estimates, the gross profit per tonne of the firm’s steel structure products fell by Rmb88/t YoY to Rmb394/t in 2024 (mainly due to fiercer competition and falling steel prices) with gross profit per tonne of the firm’s “other income” declining by Rmb15/t YoY to Rmb119/t; gross profit per tonne of the firm’s steel structure products was Rmb529/t in 4Q24 (-Rmb40/t YoY and +Rmb82/t QoQ).

Expenses rising amid continued investment in intelligent transformation: In 2024, the firm accelerated its intelligent transformation, and its depreciation and R&D expenses per tonne both trended upwards. In 2024, the firm’s R&D expenses per tonne rose to Rmb171/t, and its other G&A expenses and selling expenses per tonne were Rmb78/t (+Rmb3/t YoY) and Rmb33/t (-Rmb2/t YoY).

Impact from credit and asset impairment losses weighed on profit: The firm's credit and asset impairment losses rose considerably YoY to Rmb57.41mn and Rmb4.18mn in 2024, weighing on the firm’s profit. The firm’s full-year net profit per tonne fell by Rmb100/t YoY to Rmb178/t and recurring net profit per tonne declined by Rmb94/t YoY to Rmb111/t.

Cash flow under pressure: The firm’s net operating cash inflow fell 47.8% YoY to Rmb573mn in 2024, with accounts receivable turnover days rising by 19 days YoY to 69 days and inventory turnover days rising by 23 days YoY to 169 days.

Debt-to-asset ratio rising: Due to increased investment in intelligent transformation and high capex, the firm's net debt rose by Rmb1.65bn YoY to Rmb7.13bn. Its debt-to-asset ratio rose 1.4ppt YoY to 61.9%, and its net gearing ratio rose 14.5ppt YoY to 74.1%.

Trends to watch

Limited room for industry-wide competition to intensify further; watch for demand recovery and effect of intelligent transformation. We believe the profit per tonne of the steel processing industry has been shrinking in recent years due to falling demand and steel prices, but we see limited room for industry-wide competition to intensify further and we think declines in profit per tonne will be manageable. If steel prices recover and demand rebounds, we expect considerable upside potential in profit per tonne.

Meanwhile, the firm continues to advance its intelligent transformation (its R&D expenses rose 5.7% YoY in 2024), which we think may affect its costs in the short term but may boost the firm’s capacity expansion and economies of scale over the long term. We are optimistic that the firm’s capacity utilization rate and cost advantage will improve thanks to its intelligent transformation in the next 1-2 years, helping the firm live through impacts from the cyclical downturn in demand.

Financials and valuation

We keep our 2025 earnings forecast largely unchanged and we introduce our 2026 earnings forecast at Rmb1.14bn. The stock is trading at 13x 2025e and 12x 2026e P/E. Given the firm’s leading market position in the industry, we maintain an OUTPERFORM rating. Considering improving risk appetite, we raise our target price by 41% to Rmb24, implying 16x 2025e and 14x 2026e P/E, offering 21% upside.

Risks

Weaker-than-expected demand; sharp fluctuations in steel prices; disappointing progress of intelligent transformation.