Interpretation of IPOs | Behind the fluctuations in Rongli Construction's performance: “big customer addiction” is difficult to solve, and a single non-recurring project affects business continuity

Recently, the Hong Kong contractor Rongli Construction Holdings Limited (hereinafter referred to as Rongli Construction) passed the Hong Kong Stock Exchange main board listing hearing, and Tongren Finance Co., Ltd. was its sole sponsor.

Performance fluctuations are a rollercoaster of upward cash flow

According to the prospectus, Rongli Construction is a large-scale Hong Kong contractor engaged in civil, mechanical and electrical engineering and renewable energy projects. Its civil engineering focuses on site preparation projects and road and drainage works, while mechanical and electrical engineering focuses on cable trenching, laying and connection projects. According to industry reports, Rongli Construction is the largest cable and civil pipeline installation subcontractor in Hong Kong in 2023, with a market share of about 13.6% based on the company's revenue for the 2023/24 fiscal year. Since 2019, the company has also carried out solar photovoltaic system design, installation and maintenance projects under the Renewable Energy Division. As far as renewable energy engineering is concerned, the company focuses on solar photovoltaic projects. Second, in the few projects the company is involved in, it will temporarily lease machinery and trade construction materials from contractors and subcontractors.

During this period, all business divisions of Rongli Construction participated in several major infrastructure projects in Hong Kong. As far as the company's site preparation project is concerned, the company is one of the subcontractors involved in the third runway infrastructure project at Hong Kong International Airport; as far as the company's road and drainage works are concerned, the company is the general contractor of the government department's rural sewage collection project in Mui Wo, with a contract amount of about HK$99.1 million; for the company's mechanical and electrical engineering, the company directly signed a contract with CLP Group (a group company that supplies electricity to more than 80% of Hong Kong's population) to provide ribbon cable trenching, laying and connection works as well as emergency and cable fault repair in accordance with Master Agreement A. The company is also a subcontractor of Jincheng Construction (one of the main contractors of CLP Group) to provide ribbon cable trenching, laying and connection works as well as emergency and cable fault repair in accordance with General Agreement B. The project covers the Tsuen Wan area.

While the business progressed steadily, the company's performance showed a fluctuating growth trend. For fiscal year 2021/22, fiscal year 2022/23, and fiscal year 2023/24 (hereinafter referred to as the reporting period), Rongli Construction's revenue was $520 million (unit: HKD, same below), $361 million and $526 million, respectively, with a compound annual growth rate of 0.55%; profit during the year was $59.05 million, $405.65 million and $76.97 million, respectively, with a compound annual growth rate of 14.12%. The company's performance fluctuated, with both revenue and net profit declining for the fiscal year 2021-23.

In terms of interest rate performance, the company's gross margin was about 17.99%, 20.91% and 23.11%, respectively, and continued to grow during the period; net interest rates were about 11.35%, 11.23%, and 14.62%, respectively, with an overall steady increase.

By business, during the reporting period, the company's civil engineering business revenue was 278 million yuan, 175 million yuan and 365 million yuan respectively, accounting for 53.5%, 48.6% and 69.5% of total revenue; revenue from the mechanical and electrical engineering business was 128 million yuan, 125 million yuan and 113 million yuan respectively, accounting for 24.5%, 34.7% and 21.5% of total revenue; the revenue scale of renewable energy was 32.97 million yuan, 38.43 million yuan and 44.30.8 million yuan respectively, accounting for 6.3%, 10.5% of total revenue, 8.4% Fluctuations in the company's revenue are mainly due to the ups and downs of the largest business, the civil engineering business.

More specifically, the third runway project has always been the main driving force for the company's business and financial performance during the period. For example, in fiscal year 2021/22, fiscal year 2022/23 and fiscal year 2023/24, the third runway project contributed a total of about $255 million, $92.7 million and $241 million respectively, accounting for about 96.8%, 80.9% and 80.0% of the revenue from corresponding site leveling engineering services and about 48.9%, 25.7% and 45.9% of total revenue. According to reports, based on the total contract amount, the third runway project is one of the largest public infrastructure projects in Hong Kong, at around HK$141.5 billion. By the last practical date, the third runway project currently before the Group is expected to be completed in mid-2025. Once the company's entire project is completed, the company's revenue scale may shrink quite a bit.

In addition, revenue from site preparation engineering services built by Rongli fell 56% year-on-year to $115 million in fiscal year 2022/23, mainly due to the fact that Rongli ($#0号项目（合约金额约5 billion) and $1.389 billion) only began in December 2022 and July 2022, respectively. #08号项目（合约金额约1 As a result, most of the benefits 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 the company's performance is unstable due to differences in the timing of project confirmation of benefits. This places higher demands on the liquidity of its operations. At the end of each period, the company's cash and cash equivalents showed a roller coaster status, amounting to 13.343 million yuan, 5.47 million yuan and 27.361,000 yuan respectively.

Rongli Construction also said that as the project progresses, the company's cash flow will generally gradually shift from the net outflow in the early stages of the project to a cumulative net inflow. This situation has led to a cash flow gap, and the company's working capital may be significantly adversely affected if more projects are initially or if customers withhold large reserves of various types of projects at any given point in time.

The five major customers account for about 80% of revenue, and Hong Kong's infrastructure development has slowed almost to the ceiling

In the past, Rongli Construction was mainly engaged in public projects in Hong Kong. During the reporting period, public projects mainly involved site preparation projects and road and drainage projects. Service revenue accounted for about 65.6%, 58.4% and 73.2% of total revenue, respectively.

According to the Zhitong Finance App, the nature, scope and timing of the available public sector usually depends on the mutual influence of many factors, including the Hong Kong Government's policies on infrastructure and public facilities development, its land supply and public housing policies, and the general conditions and prospects of the Hong Kong economy. Currently, facing the challenges of fiscal deficits and declining reserves, the government's ability to allocate funds for infrastructure development may be limited.

According to Hong Kong's 2024-2025 Budget, the Hong Kong Financial Secretary anticipates a budget deficit of HK$101.6 billion for the 2023-24 fiscal year, almost double the original estimate of HK$54.4 billion. The Financial Secretary of Hong Kong anticipates that the budget deficit for the fiscal year ending March 31, 2025 will increase further from the previous estimate of approximately HK$48.1 billion.

According to section 107 of the Basic Law, the Hong Kong Government shall prepare the budget on the principle of revenue and expenditure, seek balance between income and expenditure, avoid deficits, and be in line with the growth rate of the gross domestic product. Infrastructure projects may face budget cuts or delays as the government may need to prioritize spending in areas such as education and health care, and reduce overall spending. This may affect the construction, maintenance and expansion of infrastructure such as roads, bridges, ports, and public transportation systems.

If the number of private construction projects available is drastically reduced, leading to a reduction in demand for related civil, electromechanical and renewable energy projects, the profitable business, financial situation and operating performance may be significantly adversely affected.

According to the Census and Statistics Department, the total value of civil engineering works carried out by Hong Kong's general contractors has grown at a compound annual rate of about 3.2% from 2019 to 2023. Over the next few years, projects such as the Kwu Tung North and Fanling North New Development Areas, the Kau Yee Chau Artificial Island under the Tomorrow Lantau Vision, and the Tung Chung New Town Expansion will continue to maintain demand for civil engineering. The total value of civil engineering projects in Hong Kong is expected to grow at a CAGR of 3.5% from 2024 to 2028.

Judging from the competitive landscape, the civil engineering market in Hong Kong is relatively concentrated. It is estimated that the total market share of the top three market participants in the Hong Kong civil engineering industry in 2023 will be around 22.4%. The company's revenue accounted for about 0.6% of the overall civil engineering industry market share in Hong Kong in 2023, which is not very high. Therefore, expanding market share has become the most important issue for the company's development.

To expand its share, it is necessary to acquire more projects and accumulate more customers. However, judging from Rongli Construction's customer base, the company relied heavily on a few major customers. During the reporting period, the revenue of the company's main customers was about RMB 169 million, RMB 86.1 million and RMB 172 million, accounting for about 32.4%, 24.0% and 32.6% of its total revenue, respectively; revenue from its five major customers was approximately RMB 441 million, RMB 221 million and RMB 387 million respectively.

The five major customers account for more than 80% of revenue, making the company's repayment a problem. According to the prospectus, when the right to receive payment becomes unconditional (other than the passage of time), any amount previously recognized as a contract asset will be reclassified as a trade receivable. On March 31, 2022, March 31, 2023 and March 31, 2024, Rongli Construction recorded total contract assets of approximately $127 million, $141 million and $195 million respectively. Trade receivables remain high, making the liquidity created by Rongli worse. Perhaps this is also a major reason for Rongli Construction's listing financing.

In summary, as a contractor mainly engaged in public projects in Hong Kong, Rongli Construction's business development depends on Hong Kong's infrastructure investment. Currently, the growth rate of infrastructure in Hong Kong is low, and the company is almost at its peak of growth. Also, focusing on itself, although performance fluctuated and improved during the period, it mainly relied on a single project to contribute nearly 50% of total revenue. Once the project ends in mid-2025, the company's growth may be unsustainable. Furthermore, its reliance on large customers and weak liquidity has also become a hindrance to further expanding its market share.