3Q23 earnings slightly miss our expectation

Estone Materials Technology announced its 3Q23 results: In 1-3Q23, the firm’s revenue fell 23.49% YoY to Rmb347mn, net profit attributable to shareholders declined 86.78% YoY to Rmb15mn, and recurring net profit fell 110.91% YoY to -Rmb11mn. In 3Q23, the firm’s revenue dropped 18.11% YoY and grew 19.52% QoQ to Rmb131mn, its net profit attributable to shareholders fell 88.65% YoY to Rmb4mn, and its recurring net profit declined 105.09% YoY to -Rmb1mn. The firm’s 3Q23 earnings slightly miss our expectation, mainly due to factors such as pressure on boehmite sales volume and prices, share-based payment expenses, and increased R&D expenses.

Trends to watch YoY decline in revenue narrowed in 3Q23; revenue rose 19.52% QoQ.

Over 1-3Q23, demand for lithium-ion battery (LiB) coating materials declined, resulting in a decline in the firm's shipments of boehmite products. Meanwhile, the firm lowered product prices for some clients, weighing on its revenue (falling 23.49% YoY in 1-3Q23). In 1Q23, 2Q23 and 3Q23, the firm's revenue fell 30%, 22% and 18% YoY in and the YoY decline in its revenue narrowed further in 3Q23 (its revenue rose 19.52% QoQ in 3Q23). We expect the firm’s full-year shipments of boehmite products to remain roughly flat YoY at about 25,000t in 2023, but its revenue from the boehmite business to fall 16% YoY due to price cuts.

Looking ahead, we expect the firm's shipments of boehmite products to resume growth in 2024 as downstream destocking may come to an end, competition may ease and the firm’s market share may rise. We think prices of the firm’s boehmite products will stabilize in 2024, as prices offered by the firm are close to the costs of its peers and the room for further price declines may be limited.

3Q23 gross margin up 7.08ppt QoQ; earnings to turn around gradually; increasing R&D investment and expanding presence in new market segments. In 3Q23, the firm's overall gross margin was 27.31% (down 12.54ppt YoY and up 7.08ppt QoQ), and we attribute the marked QoQ improvement in its gross margin to efforts to further reduce costs and improve efficiency. In 3Q23, the firm’s selling, G&A, R&D, and financial expense ratios rose 0.55ppt, 3.17ppt, 5.55ppt, and 1.4ppt YoY, and its overall expense ratio grew 10.67ppt YoY, mainly due to factors such as falling revenue and rising share-based payment expenses and R&D expenses. The firm continued to increase investment in R&D for new technologies, products, and production processes. In 1-3Q23, the firm’s R&D expenses rose by Rmb19.12mn or 72% YoY. The firm's R&D efforts mainly focus on new market segments such as solid oxide batteries, thermal-conductive powders, nano-carbon fibers, and highly-thermal conductive gels for 5G communications. The firm’s net profit margin was 2.85% in 3Q23, falling 17.69ppt YoY and rising 3.76ppt QoQ.

Financials and valuation

Given pressure on boehmite sales volume and prices, we lower our 2023 and 2024 net profit forecasts by 38% and 43% to Rmb79mn and Rmb132mn. The stock is trading at 37x 2024e P/E. We maintain OUTPERFORM rating. As new products may boost the firm’s long-term growth and we roll over to 2024e valuation, we cut our target price by 13% to Rmb28 (42x 2024e P/E), offering 15.8% upside.

Risks

Penetration rate of boehmite coatings disappoints; competition intensifies; development of new products disappoints.