Huadi's Year of the Tiger Starts with a Roar, But Destined to End on a Whimper?

Key Takeaways:

• Huadi International reported its revenue rose 18% in its latest fiscal year, but its profit dropped 24% on high shipping and IPO-related costs
• Company’s shares were largely unchanged after results announcement, but have rallied sharply since last October on what looks like speculative trading

By Doug Young

We’ll kick off the Year of the Tiger with a story on a relatively small maker of stainless steel pipes called Huadi International Group Co. HUDI, partly because news about our core overseas-listed Chinese companies is relatively slim this time of year. What makes Huadi interesting is less its products and newly announced annual results, and more its exploding share price.

As anyone who follows this space will know, nearly all U.S.-listed Chinese stocks took a major bath last year, most losing 50% of their value or more, amid a series of regulatory tightenings in China.

Huadi’s American depositary shares (ADSs) followed that trend for much of the year, falling steadily from their IPO price of $8 in January to a post-listing low of about $3 in October. That took its market value down to a meager $40 million, which is normally far below what we normally cover in this space.

But then something happened in early October that lit a fire under the shares, which would go on to soar as high as $35 by late December. That surge has already started to sputter, sending the shares down to their latest close of $20.85 on Wednesday. Still, the stock is currently 150% above its IPO price, giving the company a market value of $274 million.

Perhaps most revealing, the shares barely budged the day the company announced its latest annual results that showed revenue rose but profits fell on surging costs in its latest fiscal year. That would seem to indicate that something other than news is driving all the recent share volatility.

From a purely business perspective the company’s situation looks relatively tenuous due to its close ties to the home construction market. That market is showing signs of rapidly running out of steam in China, which accounted for about 80% of its sales in its latest fiscal year through September.

Its second-largest market is the U.S., which accounted for 8.8% of sales and appears on the cusp of a housing boom following a recent supply shortage. But those sales are being somewhat constrained by soaring global shipping costs.

From a regulatory standpoint, the company is probably at very low risk due to its position in a traditional industry where its main customers are home builders and it probably posses very little sensitive customer data. What’s more, the miniscule size of its sales – just $70 million in its latest fiscal year – means it’s hardly likely to draw the attention of regulators.

The bottom line of all these big-picture factors is that Huadi is in a relatively neutral position from a business and regulatory perspective. That leads us to the conclusion that the company is hardly an undiscovered “diamond in the rough” with huge potential, and more likely the huge jump in its share price is the result of behind-the-scenes trading by short-term speculators.

Which way from here?

In fact, Huadi did make a couple of relatively major announcements in November last year, right around the time of the big price jump. But both came several weeks after the huge rally began, and neither looks large enough to justify the kinds of increases that occurred.

The first came on Nov. 1, when it announced it had received an order from an unnamed U.S. client for $3.26 million worth of steel pipes. To put that in perspective, the company’s U.S. sales for all last year totaled $5.74 million, meaning the new order was equivalent to more than half of all its sales for the market in its last fiscal year. So clearly there’s potential for big growth in the U.S., especially when one considers the housing boom that many are expecting.

The second announcement came on Nov. 10, when Huadi announced a deal to supply its steel pipes to a hydrogen storage project in East China’s Zhejiang province. No value was given for the deal. But China followers will know that Beijing has placed big importance on the development of hydrogen-based power as part of its plans to go carbon-neutral by 2060.

Accordingly, this particular announcement may show that Huadi is well-positioned to participate in similar new projects in the future. It also shows the company is winning important brownie points with Beijing and the many local governments that seek to curry favor with the central government – an important element for doing successful business in China.

The first announcement sparked a 30% rally for Huadi shares, though they had already risen sharply before that. The second on the hydrogen project actually sparked a selloff that saw the shares lose a quarter of their value in a single day.

Extreme volatility for the shares in terms of trading volume also hints that there’s some speculative buying and selling taking place. The most obvious aberration occurred over a two-week period starting Oct. 20 when the shares started surging and daily volume topped 1 million and even hit 12 million on one day – well above the usual average of between 200,000 and 500,000 at that time.

Here we should point out once again that the company’s latest annual report looks very so-so. Its $70 million in fiscal 2021 sales that we already mentioned represented an 18% increase from the previous year, which is quite respectable but not spectacular for this kind of traditional industry. But its profit fell 24% to $2.53 million due to the previously mentioned rise in shipping prices, combined with extra costs related to the IPO that took place in January last year.

The one clue that hints at where Huadi’s shares might go from here lies in the company’s ratios, which all look quite inflated right now. Its price-to-earnings (P/E) ratio stands at 100, which is what you’d normally expect for a promising young internet company rather than a steel pipe maker posting low double-digit revenue growth. Its price-to-sales (P/S) and price-to-book (P/B) ratios also look relatively high at 4 and 5, respectively.

Of course, it‘s possible the shares could still rally some more as what looks like a speculative frenzy plays out. But it’s difficult to see the company retaining this kind of high valuation for too long, and more likely its shares will end the Year of the Tiger on a whimper rather than a roar.