HPG – It’s all about gross margin – Update

• 2Q22 net profit (NP) weakened 58.5% yoy following high coking coal prices and FX loss, making 1H22 NP slump 26.6% yoy.
• We lowered FY22-24F EPS by 6.3%-20.3% on higher input material prices.
• Reiterate Add with a lower TP of VND37,700, following a 13.8% average FY22-24F EPS downgrade.

2Q22 results: margin pressure tougher than our expectation
HPG posted a sharp drop of 58.5% yoy in 2Q22 NP due to weak steel demand, squeezing gross margin and FX loss. 1H22 earnings eased 26.6% yoy to VND12,249bn, fulfilling only 41.3% of our full year forecast. Gross margin extended the downtrend from 22.9% in 1Q22 to 17.5% in 2Q22 due to steeper-than-expected coking coal price hike. Meanwhile, 2Q22 hot roll coin (HRC) prices declined 15.3% yoy and 5.8% qoq due to (1) weak demand for steel pipe and galvanised steel as HRC is the key input material for these products and (2) China’s steel producers have pushed up their export volume to global markets after the dump of Russian steel into the Chinese market.

We expect gross margin pressure to ease since 4Q22F
As gross margin was only 20.4% in 1H22, we revise down FY22F GM from previous 23.5% to 20.4%, leading to a 20.3% downward revision in FY22F NP. We expect gross margin will gradually improve since 4Q22F thanks to (1) steel prices are forecasted to be more stable in the rest of 2022. We see no further downside risk for steel prices as steel mill’s capacity utilisation and inventories in the largest producer – China fell to 1-year low in Aug 2022, and (2) the sharp decline in input material prices (especially coking coal) in the last 2 months will be reflected in 4Q22’s gross margin.

The risk/reward profile is attractive for long-term investment
We now forecast HPG’s FY23-24F gross margin will pick up to 22.5%-22.2% from 20.4% in FY22 as coking coal prices are forecast will drop to pre-pandemic levels in the next two years and HPG also leverages from larger contribution of its iron ore mine in Australia. Therefore, net profit is expected to bounce back 18.7% yoy in FY23F and 8.3% yoy in FY24F. HPG is now traded at 5.1x P/E 2023, which is historical-low within the past 10 years. For longer-term, Dung Quat Steel Complex 2 (DQSC 2) is expected to come online by the end of 2024, which will make HPG to be the top30 largest steel producer in the world with a capacity of 14.6m tonnes. Thus we believe this current valuation is attractive for long-term accumulation.

Reiterate ADD with lower TP of VND37,700
We lowered FY22-24F EPS by 6.3%-20.3% on higher input material (including iron ore & coking coal) price adjustments. Thus, we revised down our TP by 15.3% to VND37,700. Upside catalyst: new business plans (aluminum and home appliance projects) to develop the value chain. Downside risk: slower-than-expected steel demand growth.
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