New Stock Interpretation | The fluctuation in Rongli Construction's performance: The dilemma of "dependence on large clients" is difficult to resolve, and the impact of a single non-recurring project on business continuity.

Recently, Hong Kong construction company Wing Lee Construction Holdings Limited (hereinafter referred to as "Wing Lee Construction") conducted a listing hearing on the main board of the Hong Kong Stock Exchange, with Human Finance Limited as its exclusive sponsor. Business performance fluctuates upwards Cash flow is like a roller coaster According to the prospectus, Wing Lee Construction is a medium-sized Hong Kong construction company engaged in civil and mechanical engineering as well as renewable energy projects. Its civil engineering focuses on site leveling and road and drainage projects, while its mechanical engineering focuses on cable trenching, laying, and connection projects. According to industry reports, Wing Lee Construction is the largest subcontractor for cable and civil pipeline installations in Hong Kong by 2023, with a market share of approximately 13.6% based on its revenue in the 2023/24 fiscal year. Since 2019, the company has also been involved in the design, installation, and maintenance of CECEP Solar Energy photovoltaic systems under its renewable energy division. In terms of renewable energy projects, the company focuses on CECEP Solar Energy photovoltaic projects. In addition, the company temporarily leases machinery to contractors and subcontractors and buys and sells building materials for some of the projects it is involved in. During the period, all business divisions of Wing Lee Construction participated in several key infrastructure projects in Hong Kong. Regarding the company's site leveling projects, the company was one of the subcontractors for the third runway infrastructure project at Hong Kong International Airport; for its road and drainage projects, the company was the main contractor for the rural sewage collection project in Mui Wo undertaken by the government, with a contract amount of approximately 99.1 million Hong Kong dollars; for its mechanical engineering projects, the company had a direct contract with CLP Group (a group company that provides electricity to over 80% of Hong Kong's population) to provide cable trenching, laying, connection projects, and emergency and cable fault repairs under Agreement A, covering the districts of Sham Shui Po and Wong Tai Sin. The company also acted as a subcontractor for Gammon Construction (a main contractor of CLP Group), providing cable trenching, laying, connection projects, and emergency and cable fault repairs under Agreement B, covering the Tsuen Wan district. While the business was progressing steadily, the company's financial performance showed a fluctuating growth trend. For the fiscal years 2021/22, 2022/23, and 2023/24 (hereinafter referred to as the "reporting period"), Wing Lee Construction's revenue was 520 million Hong Kong dollars, 361 million Hong Kong dollars, and 526 million Hong Kong dollars, respectively, with a compound annual growth rate of 0.55%; and the net profit for the years was 59.055 million Hong Kong dollars, 40.565 million Hong Kong dollars, and 76.907 million Hong Kong dollars, respectively, with a compound annual growth rate of 14.12%. The company's performance fluctuated, with a decrease in revenue and net profit in the 2022-23 fiscal year. In terms of profit margin, the company's gross profit margins were approximately 17.99%, 20.91%, and 23.11% respectively during the period, showing a continuous increase; while the net profit margins were approximately 11.35%, 11.23%, and 14.62% respectively, indicating a general trend of stability and growth. Looking at the different business segments, during the reporting period, the revenue from the company's civil engineering business was 278 million Hong Kong dollars, 175 million Hong Kong dollars, and 365 million Hong Kong dollars, accounting for 53.5%, 48.6%, and 69.5% of total revenue respectively; the revenue from the mechanical engineering business was 128 million Hong Kong dollars, 125 million Hong Kong dollars, and 113 million Hong Kong dollars, accounting for 24.5%, 34.7%, and 21.5% of total revenue respectively; and the revenue from the renewable energy segment was 32.907 million Hong Kong dollars, 38.043 million Hong Kong dollars, and 44.308 million Hong Kong dollars, accounting for 6.3%, 10.5%, and 8.4% of revenue respectively. The fluctuations in revenue were mainly due to the fluctuation of the company's primary business, civil engineering. In particular, the third runway project has been a major driver of the company's business and financial performance during the period. For example, in the fiscal years 2021/22, 2022/23, and 2023/24, the third runway project contributed service income of approximately 255 million Hong Kong dollars, 92.7 million Hong Kong dollars, and 241 million Hong Kong dollars respectively, accounting for approximately 96.8%, 80.9%, and 80.0% of the corresponding site leveling service income and approximately 48.9%, 25.7%, and 45.9% of total revenue. The third runway project is one of the largest public infrastructure projects in Hong Kong with a total contract amount of approximately 141.5 billion Hong Kong dollars. The project is expected to be completed in mid-2025. Upon the completion of the entire project, the company's revenue scale may shrink significantly. Furthermore, in the 2022/23 fiscal year, Wing Lee Construction's service income from site leveling engineering decreased by 56% year-on-year to 115 million Hong Kong dollars, mainly due to projects #0 (contract amount of approximately 573 million Hong Kong dollars) and #08 (contract amount of approximately 189 million Hong Kong dollars) only starting in December 2022 and July 2022 respectively. Consequently, most of the revenue from these two projects were not recognized in the 2022/23 fiscal year but in the 2023/24 fiscal year. It can be seen that due to the timing of revenue recognition from projects, the company's performance is not stable, which poses higher demands on its operational liquidity. At the end of each period, the company's cash and cash equivalents showed a roller-coaster trend, totaling 133.43 million Hong Kong dollars, 54.7 million Hong Kong dollars, and 273.61 million Hong Kong dollars. Wing Lee Construction also stated that as projects progress, the company's cash flow generally transitions from net outflow in the early stages of projects to cumulative net inflow. This situation results in a cash flow gap, and if more projects or customers withhold a significant amount of retention money at any specific time during the initial stages, the company's working capital could be significantly adversely affected. Approximately 80% of revenue comes from five major customers Hong Kong's infrastructure development is approaching a growth ceiling In the past, Wing Lee Construction primarily engaged in Hong Kong government projects. During the reporting period, government projects mainly involved site leveling and road and drainage projects, generating service income proportions of approximately 65.6%, 58.4%, and 73.2% of total revenue. It is understood that the nature, scope, and duration of government projects that can be obtained usually depend on a combination of factors, including the Hong Kong government's policies on infrastructure and public facility development, its land supply and public housing policies, and the general economic conditions and prospects of Hong Kong. Currently, facing challenges of fiscal deficits and declining reservesThe government's ability to allocate funds for infrastructure development may be limited.According to the Hong Kong budget for the fiscal years 2024 to 2025, the Financial Secretary of Hong Kong anticipates a budget deficit of 101.6 billion Hong Kong dollars for the fiscal year 2023-24, nearly twice the original estimate of 54.4 billion Hong Kong dollars. The Financial Secretary also predicts that the budget deficit for the fiscal year ending on March 31, 2025 will increase further from the previous estimate of approximately 48.1 billion Hong Kong dollars. According to Article 107 of the Basic Law, the Hong Kong government should prepare the budget based on the principle of balancing income and expenditure, strive for a balanced budget, avoid deficits, and adapt to the growth rate of the Gross Domestic Product. Due to the government's need to prioritize spending in areas such as education and healthcare, overall expenditure may need to be reduced, leading to budget cuts or delays in infrastructure projects. This may affect the construction, maintenance, and expansion of infrastructure such as roads, bridges, ports, and public transportation systems. If there is a significant reduction in the number of private construction projects available, resulting in reduced demand for civil, mechanical, electrical, and renewable energy engineering related to them, the business, financial condition, and operating performance of construction companies may be significantly negatively impacted. According to data from the government statistics department, the total value of civil engineering projects undertaken by contractors in Hong Kong has had a compound annual growth rate of approximately 3.2% from 2019 to 2023. In the coming years, with the completion and implementation of projects such as the North East New Territories Development in Kwun Tong North, the man-made island in the Tomorrow Lantau Vision, and the expansion of Tung Chung New Town, the demand for civil engineering is expected to be maintained, with a compound annual growth rate of 3.5% in Hong Kong from 2024 to 2028. In terms of competitive landscape, the civil engineering market in Hong Kong is relatively concentrated. It is estimated that the combined market share of the top three players in the Hong Kong civil engineering industry in 2023 is approximately 22.4%. The company's revenue accounted for about 0.6% of the overall civil engineering industry in Hong Kong in 2023, which is not high. Therefore, expanding market share is the most important issue for the company's development. To expand market share, the company needs to secure more projects and accumulate more clients. However, the company heavily depends on a few major clients, with revenue from these clients accounting for a significant percentage of the company's total revenue. The high dependence on a few major clients poses a challenge for the company in terms of cash flow. In conclusion, as a major contractor involved in public projects in Hong Kong, the business development of the company is heavily reliant on infrastructure investment in Hong Kong. However, with slow infrastructure growth in Hong Kong, the company may face a growth ceiling. Additionally, the company's reliance on a few major clients and weak liquidity could hinder its ability to further expand market share.