1H22 results in line with our expectation

Weifu High-technology’s (Weifu) 1H22 revenue fell 19.0% YoY to Rmb7.32bn, attributable net profit declined 25.1% YoY to Rmb1.23bn and recurring net profit dropped 25.5% YoY to Rmb1.27bn. Its 2Q22 revenue, attributable net profit and recurring net profit were Rmb3.0bn (-31.3% YoY and -31.4% QoQ), Rmb496.3mn (-36.7% YoY and -32.6% QoQ) and Rmb517.0mn (-32.8% YoY and -31.3% QoQ). The results were largely in line with our expectation.

Trends to watch

1H22 earnings under pressure due to numerous disruptions; better-than-sector performance demonstrating the resilience of its operations. Data from China Association of Automobile Manufacturers show that 1H22 sales volume of commercial vehicle sector fell 41.1% YoY, due to slowing macroeconomic growth, disruption from COVID-19 conditions, tightening emission regulations, slow launch of infrastructure projects, and adjustment of subsidies for agricultural machinery. However, the firm’s revenue and earnings performed better than the sector, pointing to its strong competitiveness and high market share. We attribute the outperformance to: 1) business structure adjustment and addition of platform trading business; 2) smooth expansion of passenger vehicle (especially hybrid vehicles) and off-road vehicle business; 3) growing export orders; and 4) steady ramp-up of new businesses such as alternative-fuel vehicle (AFV) parts and hydrogen fuel cells.

Gross margin improving; R&D expense ratio rising. The firm’s 1H22 gross margin rose 0.7ppt YoY to 17.7%, and attributable net profit fell 1.4ppt YoY to 16.8%. Its 2Q22 gross margin and attributable net margin were 21.9% (+5.8ppt YoY and +7.0ppt QoQ) and 16.7% (-1.4ppt YoY and -0.3ppt QoQ). Its gross margin rebounded thanks to falling raw material prices. The firm’s 1H22 expense ratio rose 2.1ppt YoY to 9.2%, due to 0.8ppt rise in G&A expense ratio and 1.2ppt rise in R&D expense ratio. We think the ongoing increase in R&D spending and accelerating development of new businesses including AFV thermal management, millimeter wave radar, smart cockpit and fuel cells, will support earnings growth in the long term.

Establishing joint-venture to expand to hydraulics business and further diversify business lines. On August 2, the firm announced plans to strategically cooperate with Bosch Rexroth (a global leader in hydraulics). The two companies plan to establish a joint-venture and develop a hydraulics brand. Weifu would hold a 50% stake in the joint-venture, and the Phase I cooperation would last until 2026. We think the cooperation will integrate the technological advantages of Bosch Rexroth with Weifu’s presence in domestic construction markets. The joint-venture may become a new growth driver for Weifu, in our view.

Financials and valuation

We maintain 2022-2023 earnings forecast unchanged. A-shares are trading at 7.1x and 6.5x 2022-2023e P/E, and B-shares at 4.8x and 4.5x P/E. We maintain OUTPERFORM rating. Considering the pressure on commercial vehicle sector and falling average valuations, we cut A-shares and B-shares TP 17.9% and 5.3% to Rmb23 (8.7x and 8.1x 2022-2023e P/E with 23.7% upside) and HK$18 (5.8x and 5.5x 2022-2023e P/E with 21.5% upside).

Risks

Fluctuating sales volume of commercial vehicles; disappointing market expansion of AFV parts business and/or hydraulics business; disappointing R&D progress for hydrogen fuel cell business.