While Lonking’s reported net profit in 2019 surged 44% YoY to RMB1.64bn, it was mainly driven by investment gains on wealth management products. Adjusted for these fair value changes, we calculate that the core net profit dropped 5% YoY to RMB1.27bn, 2% below our forecast. The weak core profit was due to the sluggish revenue (-1% YoY), which has been our concern since early last year. We see a lack of growth driver as wheel loader (Lonking’s key product), is faced with the threat of small-size excavators. We trimmed our 2020E-21E earnings forecasts by 3-6%. That said, the current price implies ~12% dividend yield (59% payout ratio in 2019), which should offer downside protection. We reset our TP at HK$2.30, based on 7x 2020E P/E. Maintain HOLD.
- Reported net profit in 2019 distorted by fair value change. Lonking’s reported net profit of RMB1.64bn in 2019 included a net fair value gain of ~RMB366mn, while the net profit in 2018 included a net loss of ~RMB238mn. This is the key reason for the high reported net profit growth in 2019. Adjusted for this and other non-recurring items, the core net profit would drop 5% YoY. In 2H19, core profit dropped 9% YoY.
- Lack of revenue growth a key concern. Revenue in 2019 dropped 1% YoY to RMB11.7bn, implying 4.5% YoY decline in 2H19, largely due to a similar rate of decline in wheel loader sales. On the positive side, gross margin improved to 24.9% in 2H19, up from 22.6% / 23.2% in 2H18 / 1H19 respectively, which we believe was helped by lower steel cost. SG&A ratio was largely stable.
- Strong balance sheet and cash flow to support dividend payout and valuation. Operating cash inflow surged 93% YoY to RMB1.57bn in 2019, implying strong cash generating capability. With proposed dividend payment of RMB976mn, payout ratio reached 59% based on the reported net profit. On the other hand, as at end-2019, Lonking’s net cash and financial investment amounted to RMB4.3bn, which represented ~50% of the current market cap.
- Upside risks: (1) strong recovery of wheel loader sales; (2) a potential target of acquisition/privatization. Downside risks: (1) slow recovery of construction activities; (2) substitution risk of wheel loader; (3) investment loss.
- Valuation not demanding but lacks catalyst. Lonking’s share price has been relatively resilient amid the volatile market, which we believe was due to the solid financial position and low valuation. We see Lonking a value play but lacks growth potential. We reset our TP as HK$2.3, based on 7x 2020E P/E, representing the average P/E since 2016 (the start of the upcycle). Our previous TP of HK$1.9 was based on 5x 2019E P/E, historical trough multiple.
