Investment positives

We initiate coverage on Ocean's King Lighting Science & Technology (OKTECH) with an OUTPERFORM rating and a target price of Rmb13.77, implying 21x 2022e P/E.

Why an OUTPERFORM rating

Replacement demand and demand for intelligent solutions boost the market for industrial lighting. OKTECH is a leading industrial lighting solution provider in China. The industry is replacing LED lights and upgrading to intelligent solutions to cut costs and enhance safety. We estimate the domestic industrial LED market is Rmb30-50bn at present. Considering that the current producer price index (PPI) is high and energy firms are willing to increase capex, we are upbeat on downstream demand and expect OKTECH to grow rapidly.

Direct sales model enhances competitiveness; providing professional customer services. In comparison with foreign-funded firms, OKTECH adopts a direct sales model which can help it gain deep insights into customer demand and innovate products to boost demand. Its sound management can be reflected by its sales, R&D, and product quality. In 2018, the firm won the Deming Prize, one of the highest awards on total quality management in the world. It is the first Chinese firm to win the prize.

Financials remain stable; labor efficiency to improve. In 2015-2021, the ratio between total sales value and the number of employees grew to around Rmb685,000 from around Rmb334,000, and the ratio between total sales value and the number of sales staff increased to Rmb975,000 from Rmb497,000. Its net profit margin grew to 18.6% in 2021 from 7.5% in 2015. We expect its per-capita efficiency to continue to improve and earnings to rise as its scale effect grows stronger and product value increases. OKTECH mainly optimizes its management via equity incentive scheme, employee stock ownership plan, or forming joint ventures. We expect this to further strengthen the firm.

How do we differ from the market

The market lacks confidence in the firm’s long-term market share and business expansion due to the lighting industry’s low barriers to entry. In our opinion, quality of customer services is the key to success in the domestic lighting industry. OKTECH has strong management capabilities, which lay a foundation for its efficient sales and R&D. We expect its efficient sales and R&D to become the firm’s core competitive advantages and help attract clients. Potential catalysts: Tenders of downstream clients and order delivery will likely recover if COVID-19 is largely brought under control.

Financials and valuation

We estimate the firm’s 2022 and 2023 EPS at Rmb0.66 and Rmb0.86, implying a CAGR of 31%. The stock is trading at 16.0x 2022e and 12.2x 2023e P/E. We think the firm should be valued at 21x 2022e P/E and 16x 2023e P/E, implying a target price of Rmb13.77. We initiate coverage of OKTECH with an OUTPERFORM rating. Our target price implies 31% upside.

Risks

COVID-19 resurgence weighs on the firm’s business operation; intensifying competition affects the firm’s earnings; loss of core employees weakens loyalty of OKTECH’s clients.