(BUY, S$1.70, TP S$2.38)
Earnings contraction due to Xinfei weakness. HLA’s 2Q11 net profit of S$19.1m was down 41% YoY. This came on the back of a 7% YoY decline in revenue. Gross profit margin declined due to higher raw material costs for Xinfei and unfavourable sales mix for Yuchai. We are lowering our FY11 net profit forecast by 13% to S$103.5m. We roll over valuation using FY12 earnings. Our revised target price is S$2.38 (20% discount to our sum-of-the-parts valuation), lowered from S$2.98 previously. Whilst the poor Xinfei performance could cap share price performance in the short term, we believe HLA’s low FY12 P/E of 5.8x makes it an attractive investment on a 12-month timeframe. The maintenance of interim dividend of 3S¢/share is another positive. Maintain BUY.
Heavy price discount for Xinfei products. Xinfei registered a 3% YoY increase to 1.0m units sold. However, competition led to heavy price discount. At the same time, higher copper and resin prices raised COGS. This led to the consumer products segment registering a marginal S$0.2m PAT, versus 2Q10’s S$15.9m. Management believes that before three of the provinces end their rural subsidy program this year, there could be increased purchases that could drive volumes.
Margin squeeze at Yuchai due to the unfavourable mix of engines. Industrial engines, which are the least profitable, accounted for 26% share in 2Q11 (versus 2Q10’s 17%), whilst higher margin medium duty engines share dropped to 20% (from 2Q10’s 30%). Yuchai remains the biggest player with a 14% market share. Management is most positive on building materials, and granite tonnage sales was up 35% YoY. There will also be a 3Q11 S$26m one-time gain from the sale of HLA’s interest in a Karimum quarry to be recorded in 3Q11, which will contribute to FY11 earnings.
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