恒立液压:3Q19profit slightly below estimate but recovery seen in Oct

Hengli’s net profit in 3Q19dropped ~4% YoY to RMB246mn, dragged by adecline in the sales volume of hydraulic cylinders which also resulted in a lowergross margin. While the result is slightly below expectations, we believe theweakness was temporary as the capacity utilization rate recovered to 100% inOct based on our understanding. We believe any share price weakness todayoffers entry opportunity. We continue to like Hengli for its import substitutiongrowth story on hydraulic cylinder, pump and valve, which we believe is structuralin nature. Stock is trading at 28x 2019E P/E.n Key highlights on 3Q19results. Revenue slightly grew 4.5% YoY toRMB1.04bn in 3Q19, which was due to a 30% YoY sales volume decline ofhydraulic cylinder for medium-size excavators. This also led to a contractionof 3.3ppt YoY on blended gross margin to 35.3%. Besides, R&D expenseincreased 36% YoY to RMB60.8mn. That said, the R&D spending growth isunderstandable as several tranches of new products are under development.All these resulted in a 3.8% YoY decline in net profit to RMB246mnn.n 9M19net profit accounted for 75% of consensus earnings. Revenue andnet profit grew 21% YoY and 27% YoY, respectively, to RMB3.8bn andRMB917mn, driven by

(1) 15% YoY revenue growth of hydraulic cylinder forexcavator,

(2) 8% YoY increase in non-standardized hydraulic cylinder forheavy equipment;

(3) 86% YoY increase in hydraulic pump and valve.Operating cash flow surged 216% YoY to RMB1.17bn, higher than the netprofit. Based on our check, the Company is running at full utilization rate withtwo shifts per day in Oct, due to order recovery. We expect earnings growthto resume in 4Q19E.n Key risks:

(1) weakness in demand for excavators;

(2) increase in componentcost.