Hongli Group (HLP) Aims For $25 Million U.S. IPO

A Quick Take On Hongli Group

Hongli Group (HLP) has filed to raise $25 million from the sale of its ordinary shares in an IPO, according to an amended registration statement.

The company provides various steel products used by manufacturers in China and overseas.

Given the uncertainties the firm faces at the regulatory level and in a high inflation environment, as well as a high valuation expectation, I’m on Hold for the IPO.

Company

Weifang, China-based Hongli was founded to design, customize and manufacture cold roll steel for various machinery and equipment for a range of industries.

Management is headed by Chairman and CEO Mr. Jie Liu, who has been with the firm since October 2009 and was previously a business degree graduate of the Nanjing Artillery Academy.

The company’s primary steel offering is sold to these industries:

• Mining

• Excavation

• Construction

• Agriculture

• Transportation

Hongli has booked a fair market value of $980,000 in equity investment from investors including Hongli Development Limited (Controlled by Chairman Liu).

Hongli – Customer Acquisition

The firm pursues customers both within China and overseas in Japan, South Korea, the U.S. and Sweden.

According to management, most of the firm’s ‘main customers increased orders with [its] PRC operating entities during the fiscal years ended 2020 and 2019, and based on their new contract with [its] PRC operating entities recently, they will continue to increase their orders in the next 2-3 years.’

Selling, G&A expenses as a percentage of total revenue have trended higher as revenues have increased, as the figures below indicate:

Selling, G&A	Expenses vs. Revenue
Period	Percentage
Six Mos. Ended June 30, 2021	14.7%
2020	17.8%
2019	12.0%

(Source)

The Selling, G&A efficiency rate, defined as how many dollars of additional new revenue are generated by each dollar of Selling, G&A spend, rose sharply to 3.6x in the most recent reporting period, as shown in the table below:

Selling, G&A	Efficiency Rate
Period	Multiple
Six Mos. Ended June 30, 2021	3.6
2020	0.9

(Source)

Hongli’s Market & Competition

According to a 2020 market research report by 360 Market Updates, the global market for cold rolled steel production was an estimated $120 billion in 2020 and is forecast to reach $147 billion by 2026.

This represents a forecast CAGR of 2.9% from 2021 to 2026.

China is the largest producer of cold rolled steel, with a market share of 54%. Europe has a 15% market share as of 2020.

Also, the industry is likely to be affected by price inflation which will filter through to OEMs and then on to consumers worldwide.

Major competitive or other industry participants include:

• China Baowu Steel Group

• NSSMC

• JFE Steel Corporation

• Shougang Group

• TISCO

• APERAM

• NLMK Group

• AK Steel

• ThyssenKrupp

• Ansteel

• Masteel

• Posco

• Cogent (Tata Steel)

• Stalprodukt S.A.

• CSC

Hongli Group’s Financial Performance

The company’s recent financial results can be summarized as follows:

• Growing topline revenue from a small base

• Increasing gross profit but lowered gross margin

• Uneven operating profit

• A swing to cash used in operations

Below are relevant financial results derived from the firm’s registration statement:

Total Revenue
Period	Total Revenue	% Variance vs. Prior
Six Mos. Ended June 30, 2021	$ 10,261,131	111.5%
2020	$ 11,158,820	20.1%
2019	$ 9,293,364
Gross Profit (Loss)
Period	Gross Profit (Loss)	% Variance vs. Prior
Six Mos. Ended June 30, 2021	$ 3,497,154	79.9%
2020	$ 4,452,517	11.5%
2019	$ 3,991,919
Gross Margin
Period	Gross Margin
Six Mos. Ended June 30, 2021	34.08%
2020	39.90%
2019	42.95%
Operating Profit (Loss)
Period	Operating Profit (Loss)	Operating Margin
Six Mos. Ended June 30, 2021	$ 1,988,972	19.4%
2020	$ 2,469,504	22.1%
2019	$ 2,880,722	31.0%
Net Income (Loss)
Period	Net Income (Loss)	Net Margin
Six Mos. Ended June 30, 2021	$ 1,458,543	14.2%
2020	$ 2,423,941	23.6%
2019	$ 2,079,406	20.3%
Cash Flow From Operations
Period	Cash Flow From Operations
Six Mos. Ended June 30, 2021	$ (563,418)
2020	$ 2,764,720
2019	$ 1,788,640
(Glossary Of Terms)

(Source)

As of June 30, 2021, Hongli had $436,718 in cash and $8 million in total liabilities.

Free cash flow during the twelve months ended June 30, 2021 was $630,125.

Hongli’s IPO Details

HLP intends to sell 5 million shares of common stock at a proposed midpoint price of $5.00 per share for gross proceeds of approximately $25.0 million, not including the sale of customary underwriter options.

No existing or potentially new shareholders have indicated an interest to purchase shares at the IPO price.

Assuming a successful IPO at the midpoint of the proposed price range, the company’s enterprise value at IPO (excluding underwriter options) would approximate $92.2 million.

The float to outstanding shares ratio (excluding underwriter options) will be approximately 21.74%. A figure under 10% is generally considered a ‘low float’ stock which can be subject to significant price volatility.

Per the firm’s most recent regulatory filing, it plans to use the net proceeds as follows:

Approximately $6.7 million or 30% for repayment for the bank loan in connection with our Expansion Plan or other usage as determined by our board(1);

Approximately $6.7 million or 30% for new production facilities under the Expansion Plan;

Approximately $2.2 million or 10% for product research and development; and

Approximately $6.7 million or 30% for working capital.

(Source)

Management’s presentation of the company roadshow is not available.

Regarding outstanding legal proceedings, management says its directors or executive officers have not been involved in any legal proceedings during the past 10 years.

The sole listed underwriter of the IPO is EF Hutton.

Valuation Metrics For HLP

Below is a table of the firm’s relevant capitalization and valuation metrics at IPO, excluding the effects of underwriter options:

Measure (TTM)	Amount
Market Capitalization at IPO	$115,000,000
Enterprise Value	$92,173,065
Price/Sales	6.94
EV/Revenue	5.56
EV/EBITDA	28.11
Earnings Per Share	$0.13
Operating Margin	19.79%
Net Margin	18.30%
Float To Outstanding Shares Ratio	21.74%
Proposed IPO Midpoint Price per Share	$5.00
Net Free Cash Flow	$630,125
Free Cash Flow Yield Per Share	0.55%
Revenue Growth Rate	111.47%
(Glossary Of Terms)

(Source)

Commentary About HLP

HLP is seeking U.S. capital market investment to pay down debt and grow its production capacity and facilities.

The company’s financials show growing topline revenue from a small base, increasing gross profit, variable operating income and a swing to operating cash burn in the most recent six-month period.

Free cash flow for the twelve months ended June 30, 2021 was $630,125.

Selling, G&A expenses as a percentage of total revenue have trended higher as revenue has increased; its Selling, G&A efficiency rate rose to 3.6x in the most recent reporting period.

The market opportunity for cold rolled steel is large but expected to grow at a slow rate of growth on a global basis.

Like other Chinese firms seeking to tap U.S. markets, the firm operates within a VIE structure or Variable Interest Entity. U.S. investors would only have an interest in an offshore firm with contractual rights to the firm’s operational results but would not own the underlying assets.

This is a legal gray area that brings the risk of management changing the terms of the contractual agreement or the Chinese government altering the legality of such arrangements. Prospective investors in the IPO would need to factor in this important structural uncertainty.

Additionally, the Chinese government crackdown on IPO company candidates combined with added reporting requirements from the U.S. side has put a serious damper on Chinese IPOs and post-IPO performance.

EF Hutton is the lead underwriter and IPOs led by the firm over the last 12-month period have generated an average return of negative (37.9%) since their IPO. This is a lower-tier performance for all major underwriters during the period.

The primary risk to the company’s outlook is the currently fast-rising price of raw materials which may reduce end user demand and cause users to seek substitute products.

While there have been recent reports of an improved regulatory approach in China, it is too early to tell whether regulatory risks will subside in the coming period.

As to valuation, compared to a basket of publicly held steel companies as compiled by noted valuation expert Dr. Aswath Damodaran, HLP is seeking an EV/Revenue valuation of 5.56x versus the basket’s 0.88x.

Given the uncertainties the firm faces at the regulatory level and in a high inflation environment, as well as a high valuation expectation, I’m on Hold for the IPO.

Expected IPO Pricing Date: To be announced