Action

SK Automation Technology (SKAT) on July 12 announced that it acquired a 51% stake in Ningde Dongheng Machinery (Ningde Dongheng) after completing the industrial and commercial registration procedures for its stake in the company. We believe the move to acquire Ningde Dongheng and add the module-related structural component business will advance SKAT's transition from the manufacturing equipment business to the manufacturing equipment and product business, creating a second growth engine and mitigating the impact of cyclicality in the customized manufacturing equipment business. We expect SKAT to grow steadily in the medium and long term given the rapid growth of the new energy vehicle (NEV) industry.

Reasoning

Demand for module and pack automation strong; profit margins to improve. Demand for module and pack production lines is strong amid the rapid production capacity expansion for electric vehicle (EV) batteries. SKAT has a leading position in the module and pack automation industry, and it has maintained close cooperation with top-tier battery companies and automakers on the back of its strong R&D competency and its experience in delivering a wide range of automation projects. We believe the net profit margin of its manufacturing equipment business will increase as: 1) demand for modular and general equipment grows; 2) the firm improves employee and efficiency management; and 3) orders from European clients as a percentage of total orders rises. We estimate that the annualized output value of the company will likely reach Rmb3.5-4bn by end-2023 as the firm increases employee and factory numbers.

Module-related structural components constitute a second growth engine; value of products per vehicle increased thanks to the use of CTP and other new technologies. Ningde Dongheng is a main supplier of module-related structural components for CATL, and it has maintained long-term relations with large customers. Companies continue to use such components after adopting cell-to-pack (CTP) and other new technologies. In addition, the value of structural components per vehicle has increased to Rmb1,600-2,000 per vehicle from Rmb800-1,000 per vehicle as new technologies impose higher performance requirements on structural components. We estimate that the size of the global market for structural components for EV modules will likely increase to around Rmb30bn in 2025 from approximately Rmb5.4bn in 2021 due to the increased installed capacity of EV batteries and the higher penetration rate of CTP and other new technologies.

Transition toward manufacturing equipment and product business to increase the growth potential of SKAT. Revenue of Ningde Dongheng jumped 118% YoY in 2021 to Rmb904mn, with net margin reaching 15.7%. We expect its earnings to grow notably going forward. The net profit of Ningde Dongheng will likely exceed that of SKAT's existing businesses in 3 years, and Ningde Dongheng may contribute incremental earnings for SKAT, in our view. In addition, we think SKAT's transition toward the manufacturing equipment and product business will make its overall business more stable, shorten its operating cycle, and improve its cash collection. Synergies between SKAT and Ningde Dongheng in product portfolios and customer resources will help SKAT improve its competitive advantage in the EV battery value chain, in our view.

Financials and valuation

We raise our EPS forecasts by 11% to Rmb3.38 for 2022 and 25% to Rmb7.14 for 2023 to reflect the financial consolidation of Ningde Dongheng. The stock is trading at 34x 2022e and 16x 2023e P/E. We maintain an OUTPERFORM rating, but raise our SOTP-based target price by 22% to Rmb148.35 (valuation of the equipment business and the structural component business at 20x 2023e and 22x 2023e P/E). Our TP implies 44x 2022e and 21x 2023e P/E, offering 27% upside.

Risks

Capacity expansion of battery companies and automakers proceeds more slowly than expected; the firm's shares in the equipment and structural component markets decline.