TSUGAMI CHINA (01651) Mid-Year Report Outlook: Consolidating in adversity, profit-making capability breakthroughs.

As the year 2023 is approaching, looking back at the past ten months, the global economic situation has been uncertain due to various unfavorable factors such as the unexpectedly tightened monetary policy by the Federal Reserve and tense geopolitical relations. Major economies are all facing varying degrees of downward pressure. International industrial cooperation has been difficult to achieve, coupled with weak domestic demand, and the recovery of China's manufacturing industry has not met expectations. The latest data shows that the domestic manufacturing Purchasing Managers' Index (PMI) for October was 49.5%, a decrease of 0.7 percentage points from the previous value, returning to the contraction range. The manufacturing production index recorded 50.9%, a significant decrease of 1.8 percentage points from the previous month, indicating a slowdown in manufacturing production. At the same time, the new order index decreased by 1 percentage point from September to 49.5%. The National Bureau of Statistics pointed out that "the proportion of enterprises in high-energy-consuming industries such as textiles, chemical raw materials and chemical products, black metal smelting and rolling processing that reflect insufficient market demand exceeds 60%". Weak terminal demand has also led to upstream machinery and equipment enterprises facing the dilemma of reduced orders and pressured performance. Taking machine tools as an example, as a typical procyclical industry, the prosperity of the machine tool industry is greatly influenced by the changes in downstream industry demand and shows a strong positive correlation with macroeconomic fluctuations. Taking TSUGAMI CHINA (01651), which has just released its latest financial report, as an observation object, the trend of its performance change is quite representative. On the one hand, despite the strong brand heritage and competitive products of Tsugami, the company's market performance in the first half of the fiscal year was still unsatisfactory due to industry adjustments. On the other hand, benefiting from Tsugami China's strict cost control, active improvement of production and sales processes, the company's profitability has increased against the trend, which also reveals the fundamental resilience of Tsugami China. Soft demand and rising profitability against the trend A review of Tsugami China's financial report for the first half of 2024 reveals that the company is under certain pressure in the current industry adjustment backdrop. The financial report shows that the company achieved revenue of 1.494 billion yuan in the reporting period, and a net profit of 221 million yuan, reflecting the considerable resilience of Tsugami China's fundamental situation. In terms of products, precision lathes remained the main source of revenue for Tsugami China in the first half of the fiscal year, with this segment generating revenue of 1.261 billion yuan, accounting for 84.4% of the company's total revenue. During the same period, revenue from precision machining centers, precision grinders, and other products were 73.961 million yuan, 81.227 million yuan, and 77.792 million yuan, accounting for 5%, 5.4%, and 5.2% of revenue, respectively. By looking at the distribution of customers in downstream industries, we can more intuitively observe the weak terminal demand. According to the data provided by the company, in the first half of the fiscal year, Tsugami China's revenue from customers in the automobile, 3C (computer, communications, and consumer electronics), pneumatic and hydraulic, and other industries was 470 million yuan, 120 million yuan, 120 million yuan, and 540 million yuan, respectively, all facing varying degrees of challenges. Among them, the revenue decline in the 3C industry was the largest, reaching 43.8% and 52.5% in year-on-year and sequential comparisons, respectively. The previously outstanding automotive industry also experienced a temporary halt in shipment growth due to the high base in previous years. In addition, it is worth mentioning that Tsugami China's revenue structure is also showing differentiation in terms of geographical regions. In the reporting period, the company's revenue from mainland China was approximately 1.249 billion yuan, roughly 80% of the same period last year. However, Tsugami China's overseas revenue during the same period was 246 million yuan, a decrease of more than 50%. This may indicate that overseas manufacturing has been significantly impacted by the high interest rate environment. In the market environment of weak terminal demand, the shrinking of Tsugami China's revenue is actually within expectations. However, when combined with the performance, Tsugami China can be considered skillful in "playing against the wind". In the first half of the fiscal year, despite a significant reduction in external orders, Tsugami China's overall gross margin increased from 24.3% in the same period last year to 27.7% this year, with an increase of 3.4 percentage points. During the same period, the company's net profit margin also changed in the same direction, increasing from 13.7% in the same period last year to 14.8% this year. In view of Tsugami China's profitability showing an upward trend against the tide, there may be two main reasons: On the one hand, in the background of continuing weak downstream demand, due to the strong brand heritage and competitive products of Tsugami, the company's bargaining power in the market remains strong, and it does not rely on price wars to compete for existing customers like middle and lower-tier manufacturers. On the other hand, in this "contrary period," Tsugami China pays more attention to cost reduction and efficiency improvement. In the first half of the fiscal year, the company actively organized employees to participate in improvement proposal activities and constantly improved processes in production, technology research and development, cost control, sales operations, etc. Additionally, the company consistently controls costs in every aspect of the supply chain. Therefore, the company's profitability also demonstrates considerable resilience. Cultivating internal strength during the economic bottoming out, preparing for the new cycle From a macro perspective, changes in downstream industry demand are important driving variables for the performance of machine tool companies. Since the change in profit indicators lags behind demand, the key to determining the turning point of the company's fundamentals may lie in observing when terminal demand stabilizes and rebounds. Although the demand for domestic CNC machine tools is still lower than the same period last year, the positive aspect is that based on the latest feedback from downstream customers, the third quarter of this year may have been a temporary bottom, and terminal demand is expected to rebound at the earliest by the end of this year. Specifically, the new energy vehicle industry, which has been booming in recent years, has experienced a contraction in capital expenditure after massive capacity expansion. Taking the lithium-ion battery industry for new energy vehicles as an example, according to data from CITIC SEC, the year-on-year growth rates of "fixed assets + projects under construction" in the lithium battery industry for 2019-2022 were 39%, 27%, 50%, and 78%, respectively, and the growth rate in the first quarter of this year was about 62%, a decrease of about 21 percentage points compared to the high point of 83% in the second quarter of 2022. However, as time enters the fourth quarter, the arrival of the peak season for sales is expected to stimulate downstream automotive OEMs to increase capital expenditure. It is understood that Tsugami China's automotive orders have recently increased.In addition, downstream demand in fields such as industrial automation, medical industry, and mold industry continue to show strong growth. Currently, TSUGAMI CHINA has a full order book in these fields, which enhances the company's future performance certainty. At the same time, TSUGAMI CHINA continues to promote its established strategy of "counter-cyclical" expansion. In the Anhui factory, the company continues to increase equipment investment and expand component processing capacity, with a full production capacity of producing 3,000 machines per year. The Pinghu new factory is expected to be completed in July next year and will have the capability of producing 4,000-5,000 machines per year. In addition to steady expansion in terms of "hardware", TSUGAMI CHINA also places great emphasis on channel construction. It actively holds subsidiary sales exhibitions and participates in various local exhibitions nationwide, strengthening its connection with end customers. In terms of data, as of September 30, TSUGAMI CHINA has accumulated a total of 416 distributors, an increase of 13% since the end of March this year; the number of existing customers has reached 8,492, an increase of 6% since the end of March this year. In the face of numerous challenges in the global economy, the domestic manufacturing industry has shown strong resilience. TSUGAMI CHINA's focus on enhancing internal dynamics and improving profitability sets a positive example for the industry in the face of possible fierce competition. At the same time, through "counter-cyclical" expansion and strengthening channel construction, TSUGAMI CHINA can have a greater impact in the next economic boom cycle, and the company's future performance elasticity is worth investors' anticipation.