Tiangong International (826.HK) Research Report | Powder Metallurgy Fills a Technological Gap, with 'Domestic Substitution' Driving Long-Term Growth

Summary:

$TIANGONG INT'L (00826.HK)$In 2020, total revenue reached approximately RMB 5.221 billion, representing a year-on-year decrease of 2.8%. However, net profit amounted to RMB 537 million, up 35.9% from the previous year—significantly surpassing the market consensus forecast of RMB 480–520 million. Revenue from the four core business segments totaled RMB 4.17 billion, marking a year-on-year increase of 4.7%. The consolidated gross margin improved by 4.3 percentage points to 23.3%. Profit attributable to owners of the parent company was RMB 537 million, up about 35.9% year on year, with earnings per share at RMB 0.209.

Additionally, during its investor conference on March 31, the company provided a brief update on its first-quarter performance, noting that revenue for January–February increased by 65% year over year and by 26% compared with 2019. The company is expected to maintain robust revenue and profit growth in 2021. Accordingly, based on the average share price in June, the company's valuation multiples for 2021–2023 are estimated at around 11x, 9x, and 7x, respectively—significantly below the market median of approximately 20x, leaving considerable room for upside. In the second quarter, the company's operations proceeded smoothly; on May 7 and May 12, it successfully issued 200 million new shares through a 'prior-old, then-new' placement, raising HKD 800 million in total. These proceeds will be primarily used to fund the construction of its Thai manufacturing facility and to bolster working capital.

We believe the company, as a global leader in tool and die steels with strong pricing power, has already raised its end-retail prices twice this year despite rising upstream raw-material costs, thereby partially passing on these cost increases to customers. Meanwhile, the robust economic recovery in Europe and North America is expected to continue supporting steady growth in relevant revenue, which leads us to be very optimistic about the company's operating performance in the first half of the year. Additionally, the company's powder-metallurgy production line fills a critical domestic technology gap and serves as one of China's strategic national reserve resources; the timely commissioning of this line is likely to deliver a significant boost to earnings over the next one to two years, aligning with the long-term trend of 'domestic substitution' for strategic resources.

In terms of business segmentation:

Mold steel:The company achieved steady growth of 6.1%, with domestic sales accounting for a substantial 47.3% increase. As global trade recovers, we expect Tiangong's foreign trade export business to rebound in 2021. In addition, the decline in raw material procurement costs has boosted the gross margin on mold steel from 25.95% in 2019 to 28.1%.

High-speed steel:Full-year revenue declined by 2% to RMB 775 million. Meanwhile, increased shipments of high-end products and powder metallurgy products boosted the overall gross margin for high-speed steel, rising from 25% in 2019 to 28% in 2020.

Cutting toolDriven by the recovery of domestic demand and the ramp-up of sales in overseas markets, the company's capacity expansion—which has progressed against the backdrop of the pandemic—and the maturation of its international sales channels have collectively fueled a 33.2% year-on-year increase in overall revenue. Notably, boosted by surging demand stemming from the global 'stay-at-home economy,' overseas revenue surged 44.5% year on year in 2020. Meanwhile, the gross margin for cutting tools also improved by 2.6 percentage points year on year to 18.9%.

Titanium alloy:Revenue declined by 47% year on year in 2020. However, given the relatively small share of revenue contributed by the restructuring business, the sluggish recovery in downstream demand did not unduly impact full-year revenue for 2020.

Competitive Landscape:

（1）European and U.S. exports are expected to rebound, and Thailand's production ramp-up is proceeding as planned:The company's 20-year profit growth rate has reached a new high since its IPO, primarily driven by rising demand for domestic substitution and an increasing share of direct overseas sales. With the continued economic recovery in developed markets such as Europe and the United States, Tiangong's overseas export segment is expected to rebound in 2021. Meanwhile, construction of the cutting tools production base in Thailand is progressing according to plan; following the commissioning of the company's first automated cutting tools plant in September 2020, annual capacity is projected to reach 48 million units, boosting gross margin by RMB 27.36 million. Demand for cutting tools from overseas customers is expected to rise further in 2021, and the company plans to expand capacity in Thailand.

（2）The new development pattern of "dual circulation" is accelerating the domestic substitution of high-end mold steels:For many years, China has relied on imports for high-end mold steels with large dimensions and long service life; estimates put the market potential for domestic substitution at 10 billion yuan. The public health crisis led to delays in the resumption of overseas production, prompting domestic customers to favor domestically produced mold steels as substitutes for imported products. In 2020, the company seized this opportunity to aggressively expand its base of high-end domestic clients, achieving a counter-trend increase of 37.8% in domestic mold steel sales (to 127,000 tonnes) and boosting its domestic market share—measured by the key special steel segment—to nearly 24.4%, up almost 4 percentage points from the previous year (an average annual increase of 3 percentage points over the past five years). Against the backdrop of the national drive to establish a new development paradigm featuring "dual circulation," the company will continue to advance the domestic substitution of high-end mold steel products that have been subject to supply-chain bottlenecks.

（3）The powder metallurgy production line has been successfully commissioned, filling a domestic gap and emerging as a new driver of performance growth.：The primary highlight for the company in 2021 is the ramp-up in powder metallurgy production. According to the company's disclosures, it achieved powder metallurgy sales of 83 tonnes in 2020, generating revenue of 9.966 million yuan with a gross margin of 48.6%. The company forecasts production capacities of 1,000 tonnes, 2,500 tonnes, and 5,000 tonnes for 2021–2023, respectively. Powder-metallurgy high-speed steel, leveraging its superior performance and quality, has been expanding into new markets; although last year's base was very low—less than 100 tonnes—the company remains confident in achieving 1,000 tonnes in sales. With current capacity at 2,000 tonnes, the company aims to exceed this target, which is expected to progressively enhance its contribution to future revenue.

（4）Optimizing the product mix, expanding the direct-sales model, and transitioning to a service-provider model will continue to enhance the company's market position and profitability:Benefiting from the domestic substitution of high-end mold steels and the increasing share of high-alloy tool and die steels in its product mix, the company has continuously optimized its product structure, which helps it avoid price wars in the mid- and low-end markets. In terms of sales strategy, the company has shifted from a distribution model to a direct-sales model (domestic sales now exceed 70%), further enhancing its profit margins. In addition, by collaborating with manufacturers specializing in blanking and heat treatment of tool and die steels, the company is gradually transitioning from a materials supplier to a materials-processing services provider. This not only strengthens customer loyalty but also improves the sales-margin profile of related products. In 2020, the gross margins for the company's mold steels, high-speed steels, and cutting tools rose to 28.1% (+2.2 percentage points), 28.1% (+3.1 percentage points), and 18.9% (+2.6 percentage points), respectively.

（5）Market position continues to strengthen, and operational efficiency keeps improving.Benefiting from increased market share, a stronger brand effect, and optimized production processes, the company has tightened credit terms with downstream customers, resulting in continued declines in both accounts receivable and inventory (down 228 million yuan and 47 million yuan, respectively, in 2020) and a year-on-year increase of 174.6% in operating cash flow to 1.307 billion yuan. At the same time, the improvement in sales profit margin has boosted the company's ROE by nearly 2 percentage points to 9.8%. Given that accounts receivable and inventory are expected to trend downward going forward, thereby enhancing total asset turnover, and that the ongoing shift toward a higher-end product mix will further improve sales profit margins, the company's ROE is poised to rise steadily to above 10%.

（6）Proposed spin-off of Tiangong Tools for an independent IPO:According to the announcement on December 28, 2020, the company introduced strategic investors, including CICC Capital, CITIC Jinshi and 11 other national-level strategic investors, who collectively invested 1.415 billion yuan to subscribe for a 16.65% equity stake in Tiangong Tools, the company's wholly owned (prior to the subscription) subsidiary. Meanwhile, Danyang Tianyi, the company's employee stock ownership platform, will subscribe for a 1% equity stake in Tiangong Tools with 85 million yuan, bringing the total financing to 1.5 billion yuan and injecting new momentum into capital operations and business development.

Risk Warning:

The global economic recovery has been slower than expected, ocean freight rates continue to increase, the RMB exchange rate keeps appreciating, and operational uncertainties persist for the company.

Risk Warning: This document provides an objective analysis based on historical data and does not constitute any form of investment advice. Investors should recognize that equity investments involve risks and that security prices can be highly volatile at times. Security prices may rise or fall, and in some cases, they may even become worthless. Trading securities does not guarantee profits; instead, it may result in losses. Investors should not make any investment decisions solely based on this material; rather, they should thoroughly review the relevant risk disclosure statements and seek advice from professional advisors. This document does not constitute an offer, solicitation, recommendation, opinion, or any guarantee regarding any securities, financial products, or instruments. It is provided by Xize Investment Management Limited ("the Company") and has not been reviewed by the Securities and Futures Commission of Hong Kong. The Company also conducts business with companies covered in its research reports. Therefore, investors should be aware that the Company may have conflicts of interest that could influence the objectivity of this report. Investors should not rely solely on this report when making investment decisions.

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