Huafeng Technology has been dedicated to connectors for more than 60 years, targeting the three major sectors of telecom, defense, and industrial production. Through a combination of innovation-driven strategies and state-owned enterprise （SOE） reform, the Company has grown steadily in recent years and has established close cooperation with customers such as Huawei, China Aerospace Science and Industry Corporation （CASIC）， China Electronics Technology （CETC）， BYD, SAIC-GM-Wuling, and ZTE. Its high-speed backplanes have broken the monopoly of overseas leading companies and are widely used in high-end routers/switches and artificial intelligence （AI） server clusters, deeply benefiting from the surge in demand for computing power. We are optimistic about its comprehensive competitiveness and rapid earnings growth and initiate coverage of the Company.

Company overview: Innovation nurtured a connector leader, and the SOE reform injects growth momentum.

Huafeng Technology has been engaged in connectors for more than six decades, focusing on three sectors of telecom/defense/industrial production. Leveraging innovation-driven strategies and SOE reform, the Company has achieved steady growth in recent years, and established in-depth cooperative relationship with customers such as Huawei, CASIC, China CETC, BYD, SAIC-GM-Wuling, and ZTE. From 2019 to 2021, the Company underwent a three-year SOE reform, implementing employee stock ownership plans （ESOPs）， stimulating corporate vitality, and introducing strategic investment. Currently, ten employee stock ownership platforms hold about 16% of the Company’s shares in total, while the Company’s executives and core employees collectively hold about 1.5% of the shares through incentive plans. As a major contributor to connector standards, the Company maintains a leading position in the fields of system interconnection and high-speed transmission. In recent years, the Company’s profit margin has significantly improved, especially in the high-speed backplane segment, and its revenues from defense and NEV connectors have experienced rapid growth. This progress has allowed the Company to turn losses into profits in 2021, with its profitability increasing rapidly. Currently, Huafeng Technology boasts a leading research and development （R&D） expense ratio compared to its peers, while its sales and management expense ratios remain stable and show signs of reduction. The Company’s core products, particularly high-speed backplanes, are likely to continue gaining competitiveness and market share, which bodes well for its future performance, indicating the potential for rapid growth.

Industry analysis: There is a vast growth space for connectors, and AI and new energy technology changes accelerate import substitution.

1） Telecom connectors: AI drives the demand surge for high-speed backplanes, and import substitution speeds up. According to Bishop & Associates, the global market of telecom connectors was close to US$20bn in 2022. High-speed backplanes, as the core component of　　mobile telecom devices, present high technical content, challenging manufacturing processes, and wide range of applications. Currently, high-speed backplanes are extensively used in high-end routers, switches, and AI server clusters. Notably, they have been adopted in products such as Nvidia’s DGX A100/H100 and GH200, as well as Huawei’s Atlas 900 AI cluster. Based on our estimates, the market of domestic high-speed backplanes reached about Rmb5bn in 2022, with Huafeng Technology breaking the overseas market’s dominance through independent innovation, and capturing a market share of approximately 5%. We expect that the market size will reach about Rmb14bn by 2026 and are optimistic about the accelerated penetration of Huafeng Technology products into Huawei and other companies. The localization rate of high-speed backplanes is likely to increase rapidly.

2） Defense connectors: With the acceleration of national defense construction, the demand for connectors continues to increase. According to the data of the Ministry of Finance, the national defense construction costs increased from Rmb532.1bn in 2010 to Rmb1,553.7bn in 2023, with a CAGR of about 8.5%. Defense connectors have high barriers and high gross profit, requiring qualification certification. In recent years, with the acceleration of national defense construction and national defense informatization, the reliability requirements of defense connectors have increased, and the industry demand is likely to continue to grow.

3） Industrial connectors: The demand for NEV connectors is surging, and the demand for rail transit connectors is improving. The electrification of automobiles has brought about extensive demand for high-voltage connectors. We estimate that by 2025, the domestic market of high-voltage connectors for NEVs will likely reach Rmb27.5bn, corresponding to a 34% CAGR from 2022 to 2025, and the localization rate is likely to continue to increase. Rail transit connectors are key components of railway vehicle equipment, with high performance requirements, strict certification systems, and high gross profit margins （GPMs）。 Currently, the scale of domestic rail transit connector market exceeded Rmb10bn. We are optimistic about the technology R&D of domestic manufacturers, and the continuous improvement of production technology and manufacturing level, which may accelerate import substitution.

Company advantages: The Company takes lead in telecom connectors, and the SOE reform has stimulated its vitality.

Huafeng Technology leads in connector technologies, and it has been a major contributor to multiple connector standards. With innovation-driven strategies and SOE reform, the Company has grown steadily in recent years. In terms of telecoms, the Company has mastered the core technology of high-speed backplanes, breaking the bottleneck of “high speed” technologies and the dominance of overseas leading companies. At present, the Company’s 56Gbps high-speed backplanes have reached the level of top foreign competitors in the industry, with key customers including Huawei. In the field of defense, the Company mainly focuses on supporting products for military equipment with high added value such as unmanned aerial vehicles and missile-borne systems. The Company also excels in system interconnection technology and other related technologies. In the field of NEVs, the Company focused on key customers such as SAIC-GM-Wuling and BYD, aiming to　　enhance its product portfolio and improve the lean manufacturing capabilities of connectors, power distribution units （PDUs） and wiring harnesses. In addition, through SOE reform and ESOPs, the Company further improves its governance capabilities and motivates its employees. We are optimistic that the Company’s management capabilities will continue to improve.

Potential risks:

Disappointing development of the Company’s high-speed backplanes; slower-than-expected AI development; less-than-expected NEV sales; less-than-expected investment in national defense construction; intensified competition in the connector industry; lower-than-expected connector prices; less-than-expected GPMs; disappointing new customer expansion.

Investment strategy:

Huafeng Technology has been dedicated to connectors for more than 60 years, targeting the three major sectors of telecom, defense, and industrial production. Through a combination of innovation-driven strategies and SOE reform, the Company has grown steadily in recent years and has established close cooperation with customers such as Huawei, CASIC, CETC, BYD, SAIC-GM-Wuling, and ZTE. Its high-speed backplanes have broken the monopoly of overseas leading companies and are widely used in high-end routers/switches and AI server clusters, deeply benefiting from the surge in demand for computing power. Considering the continuous increase in the Company’s high-speed backplane connector share and profitability, and the rapid increase in revenue from defense and NEV connectors, we forecast 2023E-25E ANP of Rmb104mn/157mn/230mn and assign 86x/58x/40x 2023E/24E/25E PE. We are optimistic about the improvement of Huafeng Technology’s comprehensive competitiveness and rapid growth in earnings and initiate coverage.