1Q22 earnings slightly lower than our expectation

Changying Xinzhi Technology announced 1Q22 earnings: Revenue grew 9.83% YoY to Rmb828mn; net profit attributable to shareholders fell 42.84% YoY to Rmb32mn, implying EPS of Rmb0.079. Rising raw material prices, the impact from COVID-19, and declining orders from customers weighed on the company’s earnings. Its 1Q22 earnings are slightly lower than our expectation.

Trends to watch

Quarterly gross margin stabilizing and likely to bottom out and rebound in 2Q22. In 1Q22, Changying Xinzhi's quarterly gross margin was 10.1%. In 1Q21, 2Q21, 3Q21, and 4Q21, its quarterly gross margin stood at a respective 16.1%, 15.3%, 12.6%, and 10.5%. The company’s gross margin continued to decline in 1Q22, but at a slower pace. Rising upstream raw material prices of remained the main reason for the decline in the company’s gross margin, and rising prices of raw materials such as copper and silicon steel had increasingly large impacts on the company’s gross margin, quarter by quarter. We believe the company's gross margin will bottom out and rebound in 2Q22 thanks to possible stabilization in prices of upstream raw materials and foreign exchange rates, and a recovery of downstream vehicle sales.

Supply bottlenecks in downstream vehicle market to ease; traditional businesses likely to recover. Automotive electric motors are the company’s traditional core business. Factors such as industry-wide chip shortages and rising prices of upstream raw materials have weighed on the company's revenue and profits. COVID-19 infections have affected auto industry supply chains in northeastern China, Jiangsu, Zhejiang, and Shanghai since the start of 2022. In the short and medium term, we believe auto industry value chains may gradually recover as the impact from COVID-19 gradually fades. Over the long term, we think the shortage of automotive chips will gradually ease. Although factors such as COVID-19, rising raw material prices, and supply shortages may weigh on its earnings in the near term, we think the company’s traditional businesses will recover thanks to industry-wide improvements over the medium and long term.

NEV-related business growing rapidly, providing growth momentum for company. Changying Xinzhi's traditional electric motor parts business enjoys a leading position in the market segment, laying a solid foundation for the company's earnings. We think businesses related to new-energy vehicles (NEV) will become a main source of revenue for the company in the future. The competitive landscape of the NEV electric drive system market is undergoing profound changes. We think the company has clear advantages in the field of NEV motor stators and rotor assembly products thanks to its resources and technological edge in the electric motor industry; it has expanded and strengthened cooperation with leading automakers, first-tier auto parts suppliers, and technology companies in the auto industry. Amid a rising NEV penetration rate, the development of high-power electric drive systems and a growing proportion of dual-motor vehicles, we expect the company to expand from stator and rotor core products to stator and rotor assembly products thanks to its leading position in the field of electric motor products, and grow into a high-quality supplier in the NEV electric drive system industry. We believe its market share may continue to rise rapidly.

Financials and valuation

Due to the impact from rising raw material prices and chip shortages, we lower our 2022 and 2023 net profit forecasts by 21.2% and 15.4% to Rmb0.21bn and Rmb0.26bn. The stock is trading at 24.1x 2022e and 18.8x 2023e P/E. Given the recovery of the auto industry and growth of the company's NEV-related business, we maintain an OUTPERFORM rating but lower our target price by 11.1% to Rmb16 (31.6x 2022e and 24.6x 2023e P/E), offering 31.1% upside.

Risks

Disappointing expansion of NEV-related business; cost control falling short of our expectation.