Midea’s Discount Dilemma: Are A-Share Investors Getting a Raw Deal
Midea Group (SZ:), which is listed on the Shenzhen Stock Exchange, announced on September 9 that it plans to sell 492 million H shares globally, with an offer price of HK$52.00 to HK$54.80 per share, and plans to raise up to nearly HK$27 billion.
Obviously, the H-share issuance price is at a discount compared to the A-share stock price. When converted into Hong Kong dollars and RMB, the discount is more than 20%. As of September 10, Midea Group’s A-share stock price closed at 60.75 yuan.
Seeing that Hong Kong stock investors can buy stocks at cheaper prices, Midea’s A-share shareholders are somewhat disappointed.
However, discount issuance is also partly due to the higher dividend tax on Hong Kong stocks. After the stock price becomes lower, the dividend rate increases. The dividend after tax is similar to that of A shares. At this point, it can be considered worthy of A-share shareholders.
And since the beginning of the year, Midea’s stock price has risen by 20%, bringing investors returns that are much higher than other consumer durables companies and indexes. In the context of the era of deflation, Midea’s low valuation and low dividends are enough to attract a large number of investors to follow.
The valuation is not high because after the company learned to walk on two legs, it achieved deterministic growth without a collapse in performance even after the real estate crash; the dividend is not low because the level of the profit center has moved up after the model change and product structure optimization, creating more funds for supply. Return to shareholders.
In the A-share market where there are not many good choices, Midea can be considered a good investment target.
1. Walking on two legs
Over the past twenty years, refrigerators have changed from direct cooling to air cooling, washing machines have changed from pulsators to drums, and air conditioners have changed from fixed frequency to variable frequency. The core technology has hardly changed.
In the days when the real estate economy was booming and people’s lives were prosperous, the market’s demand for home appliances showed high-end and differentiated development. However, as the economic growth slowed down and people began to tighten their belts, the technology of home appliances has hardly changed. In the industry, consumers’ expectations for their performance have tended to be stable, and with the same functions, they will give priority to cheaper ones.
Judging from online data, most of the sales growth year-on-year are concentrated in brands with lower average prices.
Even if low prices can make life better now, the domestic home appliance retail market has already been freezing. In 2023, the domestic home appliance retail market sales (excluding 3C) will be only 849.8 billion yuan, which is still a huge gap of 41.2 billion yuan from the high point in 2019.
As the core business accounting for 46.7% of revenue, Midea’s HVAC business also has similar growth problems. However, what is interesting is that from the perspective of overall revenue, the company has achieved sustained and stable growth, and the growth rate in recent years has been higher than Peers are faster.
This kind of growth is mainly achieved by the company’s diversification and global development. As can be seen from the table below, the company has been walking on two legs for a long time. Domestic and foreign businesses have gone hand in hand and developed in a diversified way. If domestic sales encounter growth bottlenecks, growth will be achieved through export sales, and neither side will be overly dependent.
Source: wind
With a solid monopoly in the domestic competition landscape and active expansion of promising overseas markets, the company has developed an independent growth curve that is higher than the industry.
But beauty is not without its faults. Breaking it down, the company’s business cannot be said to be simple. In addition to the to c business that has been operating for many years, it has also added the to b business, which is regarded as the second growth curve. However, the quality of the company is mixed.
2. Performance reaches new high, but the focus is still on home appliances
Recently, Midea announced its results for the first half of the year. Against the background of slow growth in the home appliance industry, revenue and profit levels hit new highs. In 2024H1, the company achieved operating income of 217.27 billion yuan, a year-on-year increase of 10.3%, and net profit attributable to the parent company of 20.8 billion yuan, a year-on-year increase of 14.1%.
The revenue growth rate in the first half of the year was consistent with the growth rate of air-conditioning revenue. The growth rate of the to B business, which was once considered to be supported by the company’s growth rate, did not catch up with the air-conditioning business and also lowered profits. It seems far-fetched to say that the to b business is the second growth curve.
Source: Midea’s 2024 interim results report
The company’s to B business includes three major categories: new energy and industrial technology, smart building technology, and robotics and automation.
Among them, smart buildings will basically grow along with the company’s electrical appliance market share growth. The new energy business is growing rapidly around the world, and the company mainly provides thermal management systems and motor products for the domestic new energy vehicle terminal market, which is still developing rapidly. These two products are also used in air conditioners. Midea’s experience is that they can be made by expanding a production line, and the synergy effect is obvious.
In April this year, the company also reached a cooperation with NIO to discuss business details for an electric vehicle parts production base based in Anqing.
The problems in the smart building and new energy business are not big. What hinders the performance of TO B business is KUKA Robot, which is too far behind Midea’s own system.
In order to quickly enter unfamiliar fields, Midea chose to acquire KUKA, one of the world’s four largest industrial robot companies. KUKA China’s revenue contribution to the KUKA Group’s overall business will increase from 17.3% in 2021 to 19.6% in 2023. The increase in revenue share in China has made Kuka become dependent on the development of Chinese industry, especially automobile manufacturers.
After 2020, China’s new energy vehicles will show a step-by-step rise, soaring to 157.5% in 2021. The growth rate of robots during the same period was also very fast. But by 2023, the industry growth rate has dropped significantly to 37.9%. Entering 2024, this growth rate will further slow down. In 2023, the domestic production capacity of new energy passenger vehicles will reach 13.46 million units. Based on this estimate, the production capacity utilization rate of new energy vehicles in 2023 will be only 57.47%.
Fewer and fewer automobile manufacturers are able to start operations, and the shrinking downstream demand has directly led to minimal growth in production and sales of China’s overall industrial robot market for three consecutive years.
As the largest market, the stagnation of demand in China has lowered the global growth expectations of industrial robots.
This puts KUKA, which is developing globally, in trouble internally and externally. In the first half of this year, due to the suspension of domestic automobile manufacturers’ production capacity expansion plans and the adjustment of overseas automobile manufacturers’ product strategies, the business unit dominated by KUKA Robots recorded a year-on-year growth rate of -9%. It is the only negative growth business in Midea Group.
In 2016, Midea made an acquisition bid for KUKA. In order to acquire KUKA, Midea did not hesitate to give a price with a premium rate of more than 60%, directly acquiring the PE of KUKA, whose stock price was less than 70 euros a year ago. 48 times, a sky-high price of 115 euros per share.
But this acquisition, which lasted six and a half years and was expected to cost 31.5 billion, consumed too much time and money. Even for Midea, which has abundant cash flow, it is a big gamble. As of 2023, KUKA Group’s revenue is 31.1 billion yuan, and it has been almost seven years and it has not even paid for the acquisition cost.
Haier, a peer of the same industry, doubled its revenue within five years after acquiring GEA. Driven by GEA, the United States has become Haier’s largest overseas market. Xiaomi, which is half a rival, has taken a big step to develop home appliances and cars. Now, not only is Xiaomi home appliances popular at home and abroad, but su7 has become an instant hit after its release. Currently, with the coordinated development of various businesses, Xiaomi Group has unlocked A new outlook for record single-quarter results.
These two examples are a good proof that Midea’s big gamble still failed. KUKA’s current earnings have not offset the purchase price, and its growth rate has dropped. After the acquisition, it still operates under the KUKA brand, which has little effect on improving Midea’s brand image.
Acquisition of this art is obviously not that simple, but fortunately the impact of this business is not large, accounting for less than ten points of total revenue. Moreover, the group’s overseas home appliance business is currently progressing smoothly, which is enough to offset the shadow of failed acquisitions.
Source: Prospectus
According to the Frost & Sullivan Report, in 2023, Midea will be the world’s largest household air conditioner manufacturer in terms of sales volume and retail sales. According to Industry Online, Midea’s air conditioner/refrigerator/washing machine sales in 2024Q2 were +12%/+9%/+2% year-on-year, respectively, of which export sales were +49%/+12%/+3% year-on-year. Whether it is industry status or growth prospects, overseas markets are more promising.
From the perspective of layout strategy, the company’s layout in emerging countries is larger, with more than 9,000 retailers in Southeast Asia joining the overseas sales platform. In the early stage, sales networks were mainly deployed in countries such as Brazil, Egypt and India.
It is relatively easy to sell independent brands in emerging markets. Not only is the market growing rapidly, but there are also a lack of strong local brands. It is easier for mature companies to use capital to quickly seize market share. The Southeast Asian market being surrounded by Japanese cars is a good example.
In addition, direct branding overseas can better build consumers’ minds. Midea, which once focused on OEM, is now also undergoing a change. In 2023, OBM revenue, mainly based on Toshiba, Midea, and Comfee brands, will account for more than 40% of overseas smart home revenue. Although ODM/OEM business still accounts for a large share of about 60% during the same period, OBM will still play an important role in improving the company’s gross profit margin. to a positive effect.
In developed markets represented by North America, Midea has entered the market with “small home appliances”. In 2023, on Amazon, the market shares of the company’s own-brand window air conditioners and microwave ovens will be approximately 28% and 44% respectively.
Faced with the world’s leading home appliance brands, which have strong competition barriers in sales channels, production base distribution and product technology, Midea, which has entered the mature market with “small home appliances”, is currently too small, but it still has opportunities through extension. Effective ways such as mergers and acquisitions can be used to achieve breakthrough. Although the degree of difficulty is not small, overseas is always a thriving blue ocean market, leaving plenty of room for imagination.
3. Firm internationalization
The determination to develop overseas has also become one of the triggers for Midea’s Hong Kong stock listing. Because being listed on the Hong Kong stock market will provide more opportunities to attract international funds, it will provide explanations for Midea to enhance its international influence.
Source: Futu
It’s just that the issuance at a discount makes existing A-share shareholders feel quite uneasy. However, in the era of deflation, the company’s profitability and risk resistance are enough to offset many concerns.
The company’s long-term development path is relatively clear. On the revenue side, it focuses more on overseas export business and uses its supply chain advantages to enjoy a 2-digit growth curve in overseas markets to make up for the weak demand in the domestic market.
On the profit side, under the cost reduction and efficiency increase due to the scale effect, unit profitability is improved, with a high single-digit net profit margin and a growth rate that is better than the revenue growth rate.
The asset-liability ratio is relatively stable, with a small proportion of financing liabilities such as loans; operating cash flow is good, and the return on equity is excellent.
Although the issuance price of H shares is 30% to 20% off the current price of A shares, as of 2023 data, Midea’s return on net assets has reached 22.23%. There are few A-share ROEs exceeding 15%, which is enough. It proves that the company has a good industry moat and long-term profitability. For A-share investors who can’t get their money out, Midea is already one of the few targets in the market that has investment value.
4. Conclusion
The relationship between home appliances and real estate is not a mutually exclusive bundle. Excellent companies generally have strict requirements on industry costs and efficiency. They build brands and pipelines during the take-off of the real estate economy, and strengthen their own strength to avoid declining along with the slowdown of the real estate economy. Shen. This kind of development thinking determines that the company’s long-term performance is often not too bad.
Midea’s performance has always maintained growth, and the latest profit growth rate even exceeded revenue, which is enough to demonstrate the company’s determination to pursue efficiency, which also indirectly ensures the stability of dividends.
More resilient earnings growth and high dividend yield are the reasons why Midea’s stock price has outperformed the market. Currently, the 12-month expected price-to-earnings ratio of Midea’s A/H shares is 10 times/9 times. It is expected to still achieve steady development on two legs in the future. The compound annual growth rate of profits is expected to be 9% from 2024 to 26, and the average dividend yield is 5 %. At a time when the stock market is experiencing a structural decline, this kind of risk-reward is already considerable.
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