1H24 results miss our expectations

Luyang Energy-Saving Materials (Luyang) announced its 1H24 results: In 1H24, revenue fell 4.2% YoY to Rmb1.61bn and net profit attributable to shareholders declined 7.6% YoY to Rmb207mn. In 2Q24, revenue dropped 2% YoY to around Rmb913mn and attributable net profit fell 9% YoY to about Rmb124mn, slightly missing our expectations due to lower gross margin of ceramic fiber and impact of newly acquired companies.

1) Solid revenue from ceramic fiber business; gross margin slightly under pressure: In 1H24, revenue from ceramic fibers fell 0.75% YoY to Rmb1.44bn, and gross margin fell 3.3ppt YoY to 31%.

2) New businesses are still in their infancy: GUTSCH Yixing (industrial filtration) and Unifrax Shanghai (automotive gaskets), the two companies acquired by Luyang from its major shareholders in 2023, contributed revenues of Rmb67.62mn and Rmb95.28mn in 1H24, with gross margins at only 6.8% and 10.6%, indicating the two companies made very limited contribution to Luyang’s revenue and profit. Luyang’s blended gross margin fell 1.7ppt YoY to 28.8% in 1H24 (gross margin fell 3.3ppt YoY to 28.6% in 2Q24).

3) Expenses continued to fall after M&As: In 1H24, the firm's selling, G&A, and R&D expenses fell 10%, 10%, and 45% YoY to Rmb104mn, Rmb69mn, and Rmb31mn, driving the overall expense ratio to fall by 2.4ppt to 12.3% (with selling, G&A, and R&D expense ratios down 0.4ppt, 0.3ppt, and 1.4ppt YoY).

4) Net margin fell slightly: Due to the drag from newly acquired companies, net margin fell 0.4ppt to 12.8% in 1H24. 5) Cash flow quality improved: In 1H24, the cash-to-revenue ratio stayed largely flat YoY at 100%, and operating cash flow rose 50% YoY to Rmb211mn (-49% YoY), implying a net operating cash flow-to-net profit ratio of 101%, up 39ppt YoY. 6) Debt-to-assets ratio remained low at 26.8% in 1H24.

Trends to watch

Developing emerging industries to fend off downside risks faced by traditional industries. In recent years, Luyang stepped up efforts to explore alternative energy, shipbuilding, and home appliance businesses, which enabled it to withstand risks from falling demand in industries such as cement, glass, and ceramics, and maintained stable revenue from ceramic fibers. Looking ahead, given the ample new production capacity in the market, Luyang will continue to gain market share and maintain the steady growth of its ceramic fiber business by keeping the capacity utilization ratio at a high level and conducting refined management.

Transfer of new technologies from major shareholders accelerates; R&D-marketing coordination and the supply side to boost demand. Looking ahead, we believe major shareholders are accelerating the transfer of high-end product technologies to Luyang (with focus on the introduction and design of new product lines in 1H24 and increasing R&D spending in 2H24), which may enable the firm to accelerate its exploration of non-ferrous metals, metallurgy, and alternative-fuel vehicle markets.

Financials and valuation

Considering demand is under pressure, we cut our 2024 and 2025 net profit forecasts 10% and 18% to Rmb479mn and Rmb522mn. The stock is trading at 11x 2024e and 10x 2025e P/E. Given its low valuation and high dividend yield, we maintain OUTPERFORM and cut our TP 16% to Rmb13.5 (14x 2024e and 13x 2025e P/E), implying 28% upside.

Risks

Technology leaks; disappointing demand for ceramic fiber and/or integration of new businesses.