Strongteam Decoration implements refined management and the strategyof serving "high-quality clients". It has gained reputation with high-qualityand stable delivery while achieving handsome profits and acquiring morehigh-quality clients. We expect Strongteam to grow into a leader of finedecoration. We put our 2020E-2022E EPS forecasts at Rmb1.60/2.15/2.88,equivalent to PE of 30x/23x/17x. By giving a certain valuation premiumbased on its better earnings growth and higher ROE and assigning atarget price of Rmb62.49 （equivalent to 39x/29x 2020E/21E PE）， we initiatecoverage with a “BUY” rating.

Focusing on fine decoration to deliver high-quality growthStrongteam has been focusing on the fine decoration industry since 2004（accounting for more than 99% of its revenue）， and currently has an annualcapacity to deliver 45,000 well-decorated homes. Benefiting from the robustindustry-wise growth and actively developing high-quality new customers,Strongteam delivered a revenue/profit CAGR of 58%/60% in 2017-2019,which compares to the industry average of only 11%/10% during the sameperiod. Meanwhile, Strongteam maintains a high profit margin throughrefined management and a well-selected client base （its net profit marginaveraged 7.9% in 2017-19 vs. the industry average of 4.1%）。

Rising penetration of fine decoration to support a Rmb1.2trn marketFine decoration companies are the final suppliers of developers before thedelivery of homes. The combination of large volume and high frequencyrequires decoration companies to have stable and reliable deliverycapabilities, which also gives them reasonable bargaining power. Thepenetration rate of fine decoration in China has rapidly increased from 12%in 2016 to 32% in 2019, which, however, still presents room for furtherimprovement compared with the overseas penetration rate of nearly 90%.

Assuming the sales of residential properties in GFA are stable, thepenetration rate of fine decoration will increase by 2.5% per year, and theunit price of refined decoration will increase slightly by 1% every year, wethen estimate that the sales in GFA/market size of fine decoration will reach900mn square meters/Rmb1.2trn in 2024, an increase of 25%/32% from2019. Combined with the increasing concentration of real estate developersand the fragmented decoration industry （CR3 at only 1.15% in 2018）， webelieve that fine decoration companies with high-quality services and goodreputation will outperform in growth.

1st advantage: Refined management brings profit and efficiency

Proprietary management: Strongteam insists on self-management ofthe entire project process with a high proportion of in-house personnel,which is reflected in its lower-than-peer per capita income （41% lower）and higher-than-industry administrative expense ratio （1.3ppts higher）。

But proprietary management strengthens both quality and cost control:

Strongteam’s overall expense ratio was 4.9% in 2019, 3.5ppts lowerthan the industry average, and its per capita profit was Rmb148,000,34% higher than the industry average.

Standardization: Strongteam standardizes labor service and constructionprocess by adopting the model of small teams instead of large teams, hiringlabor teams according to different types of work, and scheduling teams to workin accordance with the construction process, which greatly improves the projectquality and operational efficiency. The Company’s average asset turnover ratiowas 1.2x in the past five years, nearly 50% higher than the industry average.

Refined management enabled by proprietary management and standardization hastranslated into competitive advantages. Strongteam's ROE in the past five years was22.1%, which is 9.6ppts higher than the industry average.

2nd advantage: Well-selected customers ensure healthy growth1） Previously, listed companies in the fine decoration industry have adopted thestrategy of “large-account clients” by working with customers who pay more attentionto order volume than quality. These clients are often subject to high financing costs（over 10%） and are willing to subcontract part of their purchases to decorationcompanies to reduce their own financing pressure. This model enables rapid growthbut requires higher financing capabilities. With the deleveraging process in 2018, thismodel has encountered bottlenecks. 2） On the contrary, Strongteam has alwaysworked with “high-quality customers”， who pay more attention to quality. These highqualitycustomers such as Vanke enjoy low financing costs （3%~4%） and implementcentralized procurement, which enables a higher profit margin （Strongteam’saverage gross profit margin was 18.3% in the past five years, 3.5ppts higher thanthe industry average）。 On the other hand, this strategy entails no financial pressure（net gearing was 8.3% in the past five years, 12.9ppts lower than the industryaverage）， fewer accounts receivable （accounts receivable equivalent to 47.6% ofrevenue in the past five years, 42.1ppts lower than the industry average）， andexcellent cash flow （the ratio of net operating cash flow/net profit was 0.62 in thepast five years, 59% higher than the industry average）。 3） A high-quality client baseand refined management are complementary in building a virtuous closed loop. In2019, the Company's revenue from listed companies accounted for 80%, and thegrowth rate of new orders reached 23.3% in the past three years.

Potential risks

Weaker-than-expected growth of property sales; less-than-expected growth in thepenetration rate of fine decoration.

Investment recommendation

We put our EPS forecasts for 2020E-2022E at Rmb1.60/2.15/2.88, equivalent to PEof 30x/23x/17x. By giving a certain valuation premium based on its better earningsgrowth and higher ROE and assigning a target price of Rmb62.49 （equivalent to39x/29x 2020E/2021E PE）， we initiate coverage with a “BUY” rating.