2021 results in line with our forecast; 1Q22 results miss our forecast

Sinocat Environmental Technology Co Ltd (Sinocat) announced its 2021 and 1Q22 results. In 2021, revenue fell 62.7% YoY to Rmb962mn, net profit slid 95.2% YoY to Rmb10.41mn, and recurring losses came in at Rmb17.91mn. In 4Q21, revenue fell 58.5% YoY to Rmb223mn (+93.9% QoQ), and net losses stood at Rmb12.08mn. The 2021 results are in line with our expectations. In 1Q22, revenue slid 68.2% YoY or 56.8% QoQ to Rmb96.17mn, and net losses came in at Rmb10.79mn in 1Q22, while the firm reported a net profit a year earlier. The 1Q22 results slightly miss our expectations due to COVID-19 and rising energy prices driven by international geopolitical issues. Sinocat announced that it plans to set up a subsidiary to focus on R&D of solid-state batteries and relevant core materials.

Trends to watch

Sinocat’s revenue declined due to lower demand for natural gas-powered heavy-duty trucks (HDT). However, product and revenue mix improved. Natural gas prices trended upward since May 2021. China’s natural gas-powered HDT sales volume fell 58% YoY to 59,280 units in 2021. Sales volume slid 73% YoY to 6,712 units in 1Q22 as the Russia-Ukraine conflict pushed up gas prices. Sinocat’s revenue from core product (natural gas catalyst) depends on sales volume of natural gas-powered HDTs. The firm’s revenue from natural gas products fell 81% YoY to Rmb415mn in 2021 and dropped 85% YoY to Rmb26.21mn in 1Q22. The company’s product and revenue structure improved. Sinocat’s revenue from products related to diesel and gasoline vehicles rose 45% and 40% YoY to Rmb219mn and Rmb152mn in 2021. We note that the company has ample new orders and backlog projects. The implementation of the China VI emission standard for on-road vehicles (in 2021) and the China IV emission standard for non-road vehicles (end-2022) may help the firm’s earnings rebound considerably, in our view.

Profitability under pressure due to multiple disruptions; R&D spending increased rapidly. Gross margin fell 2ppt YoY to 14.9% in 2021, and slipped 6.7ppt YoY or 7.2ppt QoQ to 8.9% in 1Q22. We attribute the gross margin contraction to lower market demand and pandemic resurgence in China. R&D expense ratio rose 5.8ppt YoY to 8.4% in 2021, and expanded 13.5ppt YoY or 7.9ppt QoQ to 20.2% in 1Q22.

Forward-looking expansion into new-energy vehicles (NEV); Sinocat becoming fixed supplier of catalysts for Chang’an Auto’s hybrid vehicle; firm to mass produce catalysts for hydrogen fuel cells ahead of domestic peers. Sinocat’s subsidiary became exclusive fixed supplier of catalysts for Chang’an Auto’s hybrid vehicle CS385. We believe the efforts to turn China’s leading passenger vehicle producers into its customers will help Sinocat expand its market share. In addition, Sinocat plans to produce platinum on carbon catalysts for hydrogen fuel cells in quantities in 2022. It intends to set up a subsidiary to focus on solid-state batteries. We believe hydrogen fuel cells and solid-state batteries will become the firm’s long-term growth driver.

Financials and valuation

We cut our 2022 and 2023 earnings forecasts 35.8% and 15.4% to Rmb100mn and Rmb180mn, given rising raw material prices and weaker-than-expected recovery in the demand for natural gas powered HDTs. The stock is trading at 25.1x 2022e and 13.9x 2023e P/E. Maintain an OUTPERFORM rating. We cut our target price 27% to Rmb40, implying 34.3x 2022e and 19.1x 2023e P/E and offering 36.8% upside.

Risks

Volatile raw material prices; lower production and sales volume of commercial vehicles; slower-than-expected progress in R&D of new business.