Action

We downgrade the company to HOLD and lower our TP to Rmb11 （our previous TP changed from Rmb25 toRmb16 due to the expansion of share capital）。

What’s changed

Gross margin in 1Q17 was lower than expected. The company’s net profit in 1Q17 fell 38% YoY toRmb6.41mn, mainly because gross margin in the quarter was down 8.2ppt YoY and 3.4ppt QoQ to 16.6%. Weattribute the decline in gross margin to the rise of lead prices. We estimate lead materials accounted for 60~65%of lead-acid battery manufacturing costs. The average price of lead in 1Q17 rose >30% YoY.

Gross margin in 2Q17 is expected to remain under pressure. According to the company, net profit in 1H17is expected to be Rmb16.23mn~29.76mn, implying a YoY change of -40%~+10%; thus, net profit in 2Q17 isexpected to be Rmb9.82mn~23.34mn, implying a YoY change of -40%~+40%. Considering the current level oflead prices, we expect gross margin in 2Q17 to remain under pressure.

Valuation is fair. The company is trading at 51x 2017e P/E, vs. the average of 75x P/E over the past five years.

Considering earnings growth in 2017/2018 is expected to be slower than in 2015/2016, we think that the currentvaluation is fair.

How do we differ from the marketGiven the current level of lead prices, we expect gross margin in 2Q17 toremain under pressure.

Potential catalysts: Lead prices remain high.

Financials and valuation

We cut 2017/2018 earnings by 15%/7% to Rmb64.47mn/78.45mn, implying EPS of Rmb0.18/0.22 （sharecapital expanding to 350mn shares due to stock dividend）。 We lower our TP to Rmb11 （based on 60x 2017e P/E）。

Risks

Raw material prices changing more than expected.