What robot boost? Zhaowei Machinery faces challenge as growth stumbles

The high-precision component maker’s revenue and profit both fell in the first quarter, putting its robotics story to the test Key Takeaways: Zhaowei Machinery’s first-quarter revenue and profit both declined, with its profit down more than 25% year-on-year Buoyed by its recent Hong Kong listing, the company’s cash reserves surged to 950 million yuan by the end of March By Lee Shih Ta Making robots walk, run, and fight may be complex, but it’s much easier than making them generate profits. In the absence of such profits, makers of robots that serve tea, pour water, dance and do somersaults have instead relied on a steady flow of fresh investor capital to keep their operations running. Meantime, profits for the sector remain elusive, and revenue is unstable, even as valuations for robotic concept plays continue to rise. A case in point is high-precision component maker Shenzhen Zhaowei Machinery & Electronics Co. Ltd. (2692.HK; 003021.SZ), which many investors are treating as a robot concept play. The company profoundly understands the tenuousness of its position, reporting last week that both its revenue and profit declined in the first quarter. Investors that have flocked to robot stocks have been lukewarm on Zhaowei since its Hong Kong listing two months ago, sending its stock down about 8% from its offering price. Zhaowei doesn’t make finished robots, but rather provides power transmission and drive systems that allow robots to move. Its core products include the gearboxes, micro motors, and integrated drive modules that convert electricity into precise rotational and thrusting movements. Its products have found their way into applications in automotive electronics, consumer devices and industrial automation. The rise of robotics has also extended the use of its products into areas like robotic fingers and micro joints, giving the company a runway into the robot concept arena. But while the concept may sound good, it has yet to materialize in Zhaowei’s financials. The company’s latest report shows its revenue slipped 2.7% year-on-year to 357 million yuan ($52.3 million) in the first quarter, while its net profit tumbled 25.2% to 40.95 million yuan. Excluding non-recurring items, its profit fell by an even steeper 31.9% to 32.14 million yuan. That bigger decline in profit, compared with a relatively small revenue drop, indicates the company’s profitability is under pressure. The pressure comes primarily on the cost side. During the three-month period, Zhaowei’s R&D costs rose to about 42.8 million yuan, up 7.9% year-on-year, with selling and administrative expenses up by similar amounts. For a manufacturing firm still exploring new application scenarios for its products, upfront investment is a given. But without commensurate revenue growth, profit margins are naturally getting squeezed. A closer look at the company’s earnings structure reveals a more nuanced picture. Its first-quarter investment income reached 15.24 million yuan, nearly quadrupling year-on-year, implying that its latest profit was less the result of operational factors, and instead was heavily influenced by gains in its financial assets. Buoyed by over HK$1.8 billion ($230 million) in fresh funds from its Hong Kong IPO in March, the company’s cash jumped significantly from 217 million yuan at the end of last year to 950 million yuan at the end of the first quarter. Its total assets also swelled to 5.88 billion yuan, and its debt-to-asset ratio remained low, reflecting a markedly improved financial position post-IPO. Notably, the company invested heavily outside during the first quarter, resulting in a cash outflow from investing activities of 870 million yuan, At least some of that was likely done using proceeds from the IPO. According to Zhaowei’s earlier disclosures, it planned to use roughly 65% of the IPO proceeds for technology R&D and capacity expansion, signaling its continued focus on its core business. Growth yet to materialize Zhaowei historically focused on precision transmission components for traditional electronics sectors, and has gradually expanded into higher-end applications such as robotics as devices become increasingly sophisticated. It has also moved beyond standalone parts that were once its mainstay into integrated modules to enhance its margins and customer stickiness through the addition of greater value-added products. The company operates toward the back end of the industry chain, which means demand for its components hinges on whether finished product makers can achieve widespread commercial deployment, rather than simply creating concept products without mass markets. That distinction applies to many robot makers whose products are still largely on the drawing board, but have yet to be commercialized, even as they soak up big investor dollars. Zhaowei is further hamstrung by the relatively low unit prices for its micro-drive products, making profitability more dependent on scale than premium pricing. In the absence of explosive order growth, rising costs, combined with stagnating sales, are naturally pressuring its margins. Realizing this stark reality, investors have begun to question the wisdom of holding Zhaowei’s stock. Rival ZhongDa Leader (002896.SZ), whose business closely mirrors Zhaowei’s, currently trades at a price-to-earnings (P/E) ratio of around 212 times, towering over the high but not quite as stratospheric 87 times for Zhaowei’s Shenzhen-listed shares and an even lower 50 times for its Hong Kong stock. While Zhaowei trades at a discount to its peer, its valuation is still noticeably richer than those for traditional precision component manufacturers. Zhaowei’s high valuation compared to traditional precision manufacturers probably owes partly to its labeling as a robotics play by some investors, even if its sales have yet to reflect that potential. That leaves the company in a relatively awkward position — neither able to prove that robotic-driven demand is arriving like many are expecting, while also trading at a valuation that includes such high expectations. This type of disconnect isn’t isolated to a single company like Zhaowei. The entire robotics chain is still in its early stages, and investors have yet to figure out who will be among the first to break out with truly commercial products. Zhaowei’s current business structure, still rooted primarily in precision manufacturing, is obviously insufficient to single-handedly sustain the valuation premium conferred by the robotics concept. That may lead investors to start reassessing the gap between their earlier expectations and reality, which may help to explain why Zhaowei’s Hong Kong stock is down in the two months since its IPO. To subscribe to Bamboo Works weekly free newsletter, click here