HUAXIANG ELECTRONIC(002048)：MULTIPLE FACTORS WEIGHED ON RESULTS IN THE SHORT TERM;NORTH AMERICAN PRODUCTION CAPACITY OPTIMIZED

　　1H22 results slightly miss our forecast

    　　Huaxiang Electronic announced its 1H22 results: Revenue fell 4.13% YoY to Rmb8.15bn and attributable net profit fell 43.62% YoY to Rmb365.15mn. The firm’s 1H22 results slightly missed our expectations due to the impact of COVID-19 resurgence and higher raw material prices.

    　　Trends to watch

    　　Domestic COVID-19 resurgence, higher raw material prices, and overseas business adjustments weighed on profits. The firm’s attributable net profit in 1H22 fell 43.62% YoY to Rmb365mn, mainly because: 1) the firm adjusted its North American business in 1H22, and the business incurred losses due to factory relocation costs and new factory investment; 2) gross margin in 1H22 dropped 3.1ppt YoY to 15.8% due to high raw material prices and sea freight rates. In addition, COVID-19 resurgence in Shanghai and Changchun affected the operation of the firm’s major customers SAIC Motor and FAW, and the suspension of the firm’s thermoforming factory and joint-venture factories in Changchun also affected its revenue. We believe that with the orderly resumption of work and production at various automakers and the introduction of policies to promote automobile consumption, the firm’s results in 2H22 may recover. Sea freight rates and raw material prices have declined marginally since the beginning of 2H22. The firm’s gross margin dropped 4.45ppt QoQ in 1Q22 and 1.46ppt QoQ in 2Q22, with the drop narrowing. We think that with the decline in raw material prices, the firm’s profitability has considerable room for improvement.

    　　Continued to increase R&D investment to enhance competitiveness; operating cash flow was under pressure in the short term. The firm’s R&D expense ratio in 2Q22 rose 0.54ppt YoY and 0.32ppt QoQ to 3.9%, and R&D investment in 1H22 increased 14.5% YoY to Rmb305mn. We believe the firm’s increased R&D investment and efforts to promote transformation of products from traditional interior and exterior trim parts to lightweight, electronic, and intelligent products will further enhance its competitiveness. The firm’s SG&A expense ratio in 2Q22 rose 2.6ppt YoY and 1.07ppt QoQ to 6.85%, and net operating cash flow decreased 83.11% YoY to Rmb54mn, which we attribute to the adjustment of the North American business and the short-term impact of COVID-19 resurgence. We think that as overseas business adjustments progress and resumption of production and work accelerates, the firm’s cash flow is likely to improve.

    　　We expect the firm to accelerate its global capacity optimization and strengthen its long-term growth momentum. In 1H22, the firm advanced the transfer of US production capacity to Mexico to reduce operating costs. We believe the firm can rely on its strong management capabilities and successful experience of restructuring its European business to shorten the period of business adjustments weighing on its results. We are optimistic that the firm will improve its business structure through self-development and M&A and continue to adjust its global business presence, thereby making positive contributions to its results.

    　　Financials and valuation

    　　Considering multiple factors weigh on the firm’s results, we cut our 2022 and 2023 net profit forecasts by 21.8% and 8.7% to Rmb1.04bn and Rmb1.29bn. The stock is trading at 11.9x 2022e and 9.6x 2023e P/E. Considering the firm’s smooth development of alternative-fuel vehicle customers and future profit boost from production capacity optimization, we maintain OUTPERFORM and our TP of Rmb18.5, which implies 14.5x 2022e and 11.7x 2023e P/E and offers 21.6% upside.

    　　Risks

    　　Raw material prices rise by more than expected; overseas integration disappoints; customer development misses expectations.