Analysis of US Stock IPOs | Net profit drops by 40%, will Junyu Engineering's US financing also struggle to gain market favor?

With a surplus after submitting the application, a Hong Kong-based construction service provider Primega Group Holdings Ltd (referred to as "Junyu Engineering") (PGHL.US) finally successfully listed on Nasdaq. The company's IPO price was $4 per share, and it fell nearly 10% on the second day of listing, with a trading volume of only 200,000 shares as of August 6, attracting low attention from the capital market.

The construction sector is one of the main areas of energy consumption and carbon emissions in China. In May 2024, the State Council issued the "Action Plan for Energy Conservation and Carbon Reduction for 2024-2025", accelerating the promotion of energy conservation and carbon reduction in the building materials industry. In the prospectus disclosed by Junyu Engineering in this listing, the term "environmental protection" was also mentioned. This naturally raises investors' curiosity about Junyu Engineering's business model and the credibility of this environmental label.

Increased Revenue but Decreased Profit, Heavy Dependence on Major Clients

According to public information, Junyu Engineering is a Hong Kong-based transportation service provider that adopts environmentally friendly practices to promote the reuse of demolition materials and reduce construction waste. The company generally provides services as a subcontractor to other construction contractors in Hong Kong.

Specifically, Junyu Engineering's main businesses include earth and stone transportation, diesel trading, and construction engineering (mainly ELS engineering and bored piles).

According to the prospectus, a large amount of earth and stone materials are generated in construction, renovation, and demolition projects, with a significant portion eventually becoming construction waste. According to relevant regulations of the Hong Kong government, construction contractors are responsible for classifying and disposing of such construction waste at government-designated waste disposal facilities, and the government waste disposal facilities charge processing fees based on the weight and type of construction waste.

Among the civil and development materials generated in construction activities, only a small portion are inert materials, such as soil, rocks, and concrete, suitable for reuse and/or recycling to produce marketable products, such as in reclamation or land leveling projects. Materials like asphalt, tiles, bricks, and glass cannot be processed and recycled into sellable products.

Junyu Engineering's earth and stone transportation services are mainly provided to construction contractors to handle excavation materials (mainly earth and stone) generated in the excavation phase of infrastructure projects. During the process of handling, loading, and transporting such construction waste, the company recycles suitable materials for repeated use and resells them in the market.

Additionally, the company owns a diesel tanker with a storage capacity of 15,000 liters to purchase biodiesel from petroleum wholesale trading companies and sell and deliver it to customers at construction sites. The main customers of this business are construction contractors operating engineering machinery using biodiesel.

Lastly, the company's ELS business involves establishing support structures using steel sheet piles inserted into the soil during deep excavation construction for subsequent excavation or infrastructure construction.

It can be seen that the company's business belongs to a relatively simple construction service provider, with low technological added value. In terms of performance, despite a slight increase in revenue in the 2023 fiscal year, net profit showed a year-on-year decline.

According to the Wisdom Financial APP, in the 2022 fiscal year and 2023 fiscal year (fiscal year ending on March 31), the company's revenue was approximately $10.4831 million and $11.1431 million, respectively, with net profits of $1.9936 million and $1.1673 million, representing a year-on-year decline of about 41% in net profit In the six months ending on September 30, 2023, the company's revenue from earth and stone transportation business decreased by 26% compared to the same period in 2022; there was no revenue from diesel trading as the previous diesel project had been completed. In the construction engineering business segment, revenue increased from $139,200 in 2022 to $1,968,200 in 2023.

The company's main customers are subcontractors for foundation and site leveling in Hong Kong property development and civil engineering projects, posing a concentration risk from large clients. The financial reports indicate that in the fiscal years 2022 and 2023, the total revenue from major clients (clients contributing over 10% of revenue) accounted for 65% and 88.26% respectively, and in the six months ending on September 30, 2023, this proportion was approximately 87.61%.

Since the company's revenue mainly depends on successful bidding or accepting non-recurring earth and stone transportation quotations, without signing any long-term service agreements with customers, the company's business operations and performance will be affected if it fails to obtain projects from existing or new clients in the future.

The financial reports show that a significant portion of the company's accounts receivable comes from important clients, with the proportion of accounts receivable from major clients being 77.89%, 91.29%, and 68.17% in the fiscal years 2022, 2023, and the six months ending on September 30, 2023 respectively. If these clients experience financial changes or encounter liquidity difficulties in the future, it may lead to an increase in bad debts, thereby adversely affecting the company's performance.

Furthermore, Junyu Engineering admitted in its prospectus that as a company in the construction industry, it also faces risks such as safety construction accidents, rising energy costs, project delays, and customer payment delays.

According to the Zhitong Financial APP, for this IPO, Junyu Engineering plans to use approximately 35% of the net proceeds from this offering to expand its existing business by acquiring additional machinery and equipment including dump trucks and excavators and hiring additional employees; about 20% will be used to upgrade the information technology system to track the location and deployment of trucks to improve resource allocation and efficiency; the remaining funds will be used for working capital and other general corporate purposes.

Real Estate Market Recovery Boosts Construction Industry Sentiment

Since the relaxation of control measures after the epidemic, the Hong Kong construction industry has shown signs of recovery and remained relatively stable in 2023. Overall in 2023, the total nominal value of construction projects completed by major contractors amounted to HKD 271 billion, an 8.8% year-on-year increase; after excluding the impact of price changes, the total value of construction projects completed by major contractors in 2023 increased by 9.9% in real terms.

Data shows that the compound annual growth rate of the Hong Kong construction industry from 2016 to 2019 was 3.41%. In 2020, due to the epidemic, it experienced a sharp decline of about 17.3%, but in recent years, the market has slowly warmed up

As of the first half of 2024, with the comprehensive withdrawal of the cooling measures in the real estate market, the Hong Kong property market is showing a prosperous scene. Institutional monitoring data shows that in the first half of this year, the overall transaction volume of residential properties priced above 20 million Hong Kong dollars in Hong Kong has increased by 1.3 times, reaching a new high in two and a half years.

The increase in property transactions has also driven the recovery of the construction industry. According to data released by the Hong Kong government's Census and Statistics Department, the nominal total value of construction projects completed by major contractors in Hong Kong in the first quarter of 2024 amounted to 68.7 billion Hong Kong dollars, an increase of 8.7% compared to the same period in 2023.

By analyzing the main categories of construction projects, the nominal total value of residential building construction projects completed in Q1 was 20.1 billion Hong Kong dollars, an increase of 48.4% compared to the same period last year; the nominal total value of transportation construction projects completed increased by 10.4% to 11 billion Hong Kong dollars.

However, as we enter the second half of the year, the positive sentiment brought about by the withdrawal of cooling measures is gradually fading, and the atmosphere in the Hong Kong property market continues to be subdued. The latest research from Centaline Property shows that in the second quarter of 2024, over 60% of newly built private residential units remain unsold, a stark contrast to the past few years. Due to the absorption of a large amount of purchasing power in the first half of the year, the large number of unsold properties will pose challenges to the property market in the second half of the year.

Wang Meifeng, Managing Director of Centaline Mortgage, stated that in the second half of the year, especially in the fourth quarter and next year, with the gradual increase in positive factors in the property market, including the Fed's rate cut starting in September this year, the expected decline in Hong Kong's prime rate in the fourth quarter, and the gradual improvement in bank mortgage policies, it is expected to increase market confidence. Buyers who take advantage of the low prices are expected to boost market sentiment, and property prices are expected to stabilize within the year.

In conclusion, from a business logic perspective, although Junyu Engineering mentioned the term "environmental protection" in its prospectus, the company's business model is essentially just a construction service enterprise involved in partial building material recycling. Being a traditional construction company without the high added value of a tech company, and with unimpressive performance, it is reasonable for the company to be coldly received by investors after going public