Investment Highlights:
China’s renowned lubricant manufacturer. Gaoke is one of the firstprivate enterprises to engage in the R&D, manufacturing and sales ofindustrial and automotive lubricants in China. With over 200 productsunder 13 categories, its products span across lubricants fortransformers, internal combustion engines, gears, special solvents andmetal processing oil, which are mainly applied in the power andelectronics equipment, industrial machinery, engineering, automotiveand other fields.
High grade lubricant products to underpin demand growth.Following progress in China’s industrialization process and shiftingtrends on the consumption of industrial lubricants, the proportion ofhigh grade products has been consistently on the rise. Demand forhigh grade lubricants as a percentage of total consumption has risenfrom 19.8% in 2005 to 25.9% in 2014. We forecast the organic growthrate of earnings for the lubricant market will be 5-7% in the future, ofwhich, growth for the high-grade segment will exceed 10%,underpinning the expansion of the entire industry. We also forecastincremental capacity will maintain a growth of~8% p.a. going forward,leading to a balanced industry landscape.
Expected to expand its market share leveraging on high gradeproducts. In terms of international experience, the quality of lubricantproducts has been gradually improving throughout the development ofthe industry. “Green oil” has become the main direction for globalmanufacturers. We believe domestic manufacturers are alsoconverging toward their international counterparts. Gaoke is mainlyengaged in the production of high grade lubricants, with R&D being itscore competitiveness. Apart from boasting 12 patents as well as manycore technologies, Gaoke is also undertaking R&D on ten newprojects. Steady investments into R&D over the long-term coupled withextensive technology in the pipeline not only allow Gaoke to maintainits edge over its rivals, they also help the Company to continually lift itsmarket share.
Continued expansion via M&As thanks to its first-moveradvantage. International experience suggests global lubricant giants(such as Shell and ExxonMobil) have all based their expansion oninternal R&D and external M&As. Thanks to its first-mover advantageand extensive industry experience, Gaoke has already built up a superreputation and client base. In addition, Gaoke is currently the onlyA-share listed company dedicated to the production of lubricants. Weanticipate the Company to continually undertake M&As by tapping thecapital markets, in order to expand its service areas.
Risks: (i) macroeconomic growth falling short of expectations; (ii) lower-than-expected demand forlubricants; (iii) sharp fluctuations in global oil prices; (iv) disappointing progress from its projects funded byits IPO proceeds
Earnings forecast, valuation and investment rating. Gaoke is relatively well known for its production andprocessing of lubricants. Its product quality has also gained recognition from its customers. Gaoke’s highgrade lubricant production project funded by its capital raising is in line with the industry’s direction as wellas market demand, which we believe will help to underpin the steady growth of its future earnings. Weforecast its 2015-17E EPS to be Rmb0.53/0.62/0.71. The stock is currently trading at 2015-17E P/E of23/20/17x. Taking into account the valuation of its comparables, we apply 25x 2016E P/E, translating into atarget price of Rmb15.5. Initiate coverage with BUY.
