Gearing Up for Long-term Growth
Prinx Chengshan ranks No. 5 in All Steel Radial Tire market among domestic makers in China. With the production capacity enhancement in its China and Thailand factories, the company’s sales volume is expected to increase. Coupled with the higher premiums for its Thailand-made auto tires vs Chinese-made products and more revenue contribution from the deep cooperation business model, we estimate its GPM to widen in 2019E/20E. Even though we expect a surge in G&A expense in 2019 due to the new plant, the expense ratio is likely to reduce while the earnings go up once the new factory runs smoothly. We initiate BUY with a TP of HK$7.5, suggesting 20% upside potential.
New production capacity boosts sales volume growth: Prinx Chengshan kicks off its production capacity expansion in 2019 due to the near saturation of its capacity and it plans to increase designed production capacity from 12.4 mn units to 22.0 mn units (77% increase) in the future. We estimate that the combined production capacity of 5.65 mn units would be added in the 1st and 2nd phases in 2019E-20E. Besides, the demand for E-commerce logistics is going strong, which is likely to increase Prinx Chengshan’s auto tires sales. Therefore, we expect revenue growth of 14%/21% yoy in 2019E/20E.
Increasing contribution from deep cooperation business model bodes well for GPM growth: The company’s GPM is sensitive to the fluctuations in raw material price. Given the little change in rubber (accounted for 47% of total raw materials cost) price in 7M2019, we estimate the company’s GPM will remain stable in 2019E. In addition, the increase in sales contribution from the deep cooperation business model (a model that Prinx Chengshan bypasses its distributors and sends the products directly to retail stores to save the transportation costs and shorten the delivery time) may bolster Prinx Chengshan’s GPM going forward.
Surge in expenses ratios may hurt 2019E earnings: The management guided that its G&A and R&D expenses ratios will increase significantly in 2019E due to the workers increase and new products development, which may hurt its 2019E earnings.
Robust balance sheet with net cash position: Prinx Chengshan was in a net cash position in 2015-2018. We estimate its borrowings to rise in 2019E-2020E given the production capacity enhancement. However, considering its robust balance sheet, the company’s net gearing ratio may stay low during the expansion.
Initiate BUY. Despite an expected increase in expenses ratios in 2019E to drag down the earnings, the performance is likely to improve after 2020E on account of new capacity added. We also have confidence that the company will benefit from the E-commerce development and industry consolidation. Therefore, we initiate BUY with a target price of HK$7.5, implying FY19E P/E of 9.2x and FY19E P/B of 1.3x.
