First Tractor:Product mix upgrades boost gross margin-131031

Results lower than expected

    1~3Q13 net profit attributable to shareholders was Rmb262mn(-18.34% YoY); operating revenue was Rmb9.251bn (-3.32% YoY).

    3Q13 operating revenue fell 9.00% YoY to Rmb2.62bn; net profitattributable to shareholders grew 16.54% YoY to Rmb69mn.

    Profit fell faster than revenue grew over January~September,mainly due to: 1) expense ratio increased despite the widening grossmargin; 2) asset impairment provisions increased Rmb87.61mn(+Rmb66mn YoY) due to bad debts and goodwill impairment fromthe acquisition of Changchun Tractor, dampening net profit.

    Gross margin widened 1.47ppt, as: 1) revenue from high-GM motorpower and mid-size/large tractor business grew, while revenue fromlow-GM small tractor business slid; and, 2) the company strengthenedcost controls and management by promoting cost optimization project.

    Trends to watchFull-year mid-size/large tractor sales volume will likely exceed thetarget of 91,000 units, but large-sized tractor sales volume may be<40,000 units. Mid-sized tractor sales volume grew rapidly grew andwill likely exceed 50,000 units in 2013.

    The company is still in a consolidation stage. Recently acquiredChangchun Tractor lost ~Rmb24.36mn in 1H13 and might be~Rmb70mn in the red for the full year. It will take time for acquiredassets to turn profitable.

    Earnings revisions

    We lower our earnings forecasts for 2013 and 2014 by 23% and24.5% to Rmb285mn (EPS Rmb0.29) and Rmb306mn (EPSRmb0.31), implying an 18.3% YoY decline and growth of 7.2%.

    Valuation and recommendationFirst Tractor-A/-H are trading at 30.5x/14.6x 2013e P/E and28.5x/13.6x 2014e P/E. Market expectations of positive policies willbe share price catalysts. Maintain ACCUMULATE and grantH-share TP of HK$5.65, implying 15.5x 2013e P/E.

    Risks

    Fierce industry competition; big losses of Changchun Tractor.