1Q17 in line

Huawu Brake announced its 1Q17 results: revenue was Rmb115mn (-3.2% YoY) and net profit attributable toshareholders was Rmb10.76mn (+3.1% YoY) or Rmb0.03/share, in line with expectations.

Revenue and gross margin both declined. After the consolidation of Ande Technology, revenue slipped 3.2% YoY,mainly caused by the weak downstream demand from metallurgy, mines and ports. Moreover, gross margin dropped5.7ppt YoY, mainly due to intensified competition and rising raw material prices.

Higher expense ratio; investment returns from its acquisition of Huanyu; net margin expansion. Salesexpense ratio rose 3.1ppt YoY on weakened economies of scale; G&A/financial expense ratio fell 0.5ppt/1.3ppt YoY.

After acquiring Huanyu Garden Construction in January, investment returns increased from -Rmb690,000 a year ago toRmb6.71mn in 1Q17, driving up net margin by 0.6ppt YoY to 9.4%.

Decline in net operating cash outflow. As of end-1Q17, inventory +Rmb32.07mn, accounts payable +Rmb6.95mnand AR -Rmb14.04mn from start-2016. Net operating cash outflow dipped Rmb23.66mn YoY to Rmb1.44mn.

Trends to watch

Solid earnings contribution from Ande Technology and Huanyu Garden Construction. In July 2016, Huawucompleted its acquisition of Ande Technology, which promised recurring net profit of no less thanRmb32.50mn/42.25mn for 2017/18. In January 2017, it acquired 25% of Huanyu, which will likely contributeinvestment returns of Rmb37.50mn/50mn/62.50mn in 2017/18/19e.

Watch for accelerated progress in trail transit. Huawu announced it would add another Rmb20mn to Huawu RailTransit’s registered capital. In 1Q17, rail transit brought in Rmb2.06mn revenue and incurred losses of Rmb2.48mn.

Watch for the delivery of rail transit orders to accelerate.

Valuation and recommendation

We maintain our earnings forecasts for 2017/18. The current share price implies market cap of Rmb5.2bn.

We maintain our BUY rating and Rmb15.26 target price, implying Rmb5.8bn market cap and 30% market share.

Risks

The expansion of rail transit products disappoints.