Huadi International Group (HUDI) intends to raise $29 million from the sale of its common stock in an IPO, according to an amended registration statement.

Wenzhou, China-based Huadi was founded to design and manufacture steel pipe and related products for use in a variety of end markets and in over twenty countries worldwide.

Management is headed by founder and Chairman Mr. Di Wang, who has held numerous positions in industry associations and regional government.

Below is a brief overview video of how seamless stainless steel tubes are made:

Source: How its made

Huadi is focused on manufacturing high-end products and sells to over 400 customers in China and overseas, with a majority of its products being used in the oil & gas, electric energy and automotive industries.

The firm has received at least $22.5 million from investors including founder and Chairman Di Wang and Jueqin Wang.

Huadi sells its products both through a direct sales force and through distributors depending on location and customer.

The firm's major customers include China National Petroleum Corporation, Sinopec, and CRRC in China; in India its major customer is a 'leading power company.'

Allied Stainless Group was its largest single customer and accounted for 10.13% of its 2019 revenue.

Selling, G&A expenses as a percentage of total revenue have risen as revenues have fluctuated.

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, swung to negative (3.4x) in the most recent reporting period.

According to a 2020 market research report by Grand View Research, the global steel pipes and tubes market was an estimated $142 billion in 2019 and is expected to reach $216 billion by the end of 2027.

This represents a forecast CAGR of 6.2% from 2020 to 2027.

The main drivers for this expected growth are a continued increase in oil & gas production, which is a major source of demand.

However, the outbreak of the Covid-19 pandemic has reduced demand in key industries such as manufacturing, oil & gas and construction over the near term.

Also, the United States is a very large user of steel pipes & tubes and the chart below shows its historical and forecast market size by application type:

huadimkt

Major competitive or other industry participants include:

  • ArcelorMittal (MT)
  • United States Steel (X)
  • Nippon Steel (OTCPK:NISTF)
  • Tata Steel
  • Jindal Steel & Power (OTC:JIZDY)
  • Rama Steel Tubes
  • Steel Authority of India

Huadi’s recent financial results can be summarized as follows:

  • Contracting topline revenue
  • Falling gross profit but increased gross margin
  • Reduced operating
  • Increased cash flow from operations

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

huadipl

Source: Company registration statement

As of March 31, 2020, Huadi had $796,381 in cash and $43.1 million in total liabilities.

Free cash flow during the twelve months ended March 31, 2020, was $450,377.

HUDI intends to sell 3.6 million shares of common stock at a proposed price of $8.00 per share for gross proceeds of approximately $28.75 million, not including the sale of customary underwriter options.

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

It is common for overseas firms to offer shares to U.S. investors in the form of AMerican Depositary Shares, or ADSs, as a way to reduce administrative burden, so the absence of this typical feature is notable.

Assuming a successful IPO at the midpoint of the proposed price range, the company’s enterprise value at IPO would approximate $137 million.

Excluding effects of underwriter options and private placement shares or restricted stock, if any, the float to outstanding shares ratio will be approximately 27.19%.

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

huadiuse

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

Listed underwriters of the IPO are Craft Capital Management, R.F. Lafferty & Co. and Shengang Securities Company.

Commentary

Huadi seeks U.S. public capital to fund its expansion plans with a small IPO.

The firm’s financials show the ill effects of the Covid-19 pandemic on customer demand, sharply reducing topline revenue and gross profit.

However, the firm has managed its bottom line and operating cash flow well, continuing to produce positive results despite the demand drop.

Sales and marketing expenses as a percentage of total revenue have risen and its efficiency in this regard has swung into negative territory as a result of the topline revenue drop.

The market opportunity for steel pipe manufacturing is expected to grow at moderate rate owing to forecast increases in demand in the oil & gas, manufacturing and construction industries.

Craft Capital Management is the lead left underwriter and there is no data on IPOs led by the firm over the last 12-month period.

As a comparable-based valuation, management is asking IPO investors to pay a premium over comparable U.S. Steel, although the two firms are not exactly alike.

I view the IPO price as reasonable given the firm’s continued positive earnings in a down economic environment.

Like many Chinese firms seeking to tap U.S. markets, the firm operates within a structure where U.S. investors would only have an interest in an offshore firm with uncertain rights to the firm’s operational results.

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

Notably, many of the firm’s entities have been incorporated in Hong Kong, where in the past it has been easier for them to serve U.S. and other foreign customers.

With the recent crackdown by Beijing on Hong Kong, this advantage may be under some question as to the terms under which these businesses may operate.

While the IPO may be reasonably priced, I’m skeptical of demand coming back quickly in the near term.

The rebound from the Covid-19 pandemic will be slower than many think and firms like Huadi that are heavily exposed to industries affected by it will suffer for a prolonged period as a result.

Given this outlook, my opinion on the IPO is NEUTRAL.

NEUTRAL

Expected IPO Pricing Date: December, 2020.

Glossary Of Terms

(I have no position in any stocks mentioned as of the article date, no plans to initiate any positions within the next 48 hours, and no business relationship with any company whose stock is mentioned in this article. IPO stocks can be very volatile in the days immediately after an IPO. Information provided is for educational purposes only, may be in error, incomplete or out of date, and does not constitute financial, legal, or investment advice.)

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