2021 results miss our forecast

Sanchuan Wisdom announced 2021 results: Revenue slid 0.1% YoY to Rmb937mn and net profit attributable to shareholders declined 11% YoY to Rmb189mn. The results missed our forecast, mainly due to relatively high prices for raw materials. In 4Q21, revenue fell 10% YoY to Rmb299mn, and attributable net profit declined 22% YoY to Rmb55mn.

Revenue from smart water meters down YoY; GM declined YoY due to high raw material costs. In 2021, revenue from mechanical water meters rose 9% YoY to about Rmb260mn, while revenue from smart water meters fell 10% YoY to Rmb513mn. The firm's overall gross margin (GM) dropped 3.9ppt YoY to 33.1% in 2021 and 5.4ppt YoY to 30.9% in 4Q21. GM of mechanical water meters fell 5.2ppt YoY to 18.4%, and GM of smart water meters declined 1.3ppt YoY to 39.0% in 2021, mainly dragged by high commodity prices that accounted for a large proportion of the costs of mechanical water meters.

Expense ratio rose YoY; equity investment income increased YoY. The firm's expense ratio rose YoY in 2021. Specifically, the financial expense ratio dropped 0.2ppt YoY and the selling, G&A, and R&D expense ratios increased 0.7ppt, 0.7ppt, and 0.2ppt YoY. In 2021, the firm’s net investment income jumped 46% YoY to Rmb103mn, as Yingtan Water Supply Group's profit increased sharply, driven by higher income from a water supply engineering project in Yingtan. This project contributed Rmb70mn of investment income to Sanchuan Wisdom. In 2021, the firm's net operating cash inflow increased by Rmb31mn YoY to Rmb84mn.

Trends to watch

We see large upside for the long-term penetration rate of smart water meters. In 2021, smart water meters accounted for about 61% of total revenue from water meters at Sanchuan Wisdom, growing by about 20ppt in the past four years and driving an Rmb40 increase in the average selling price of the firm's water meters to Rmb106. Data from Ningbo Water Meter Group shows the domestic sales volume of water meters reached about 80-90mn units in 2021. Smart meters as a percentage of total sales volume of water meters stood at about 30%, while smart meters as a percentage of existing water meters was 10-20%. Compared with the penetration rates of smart electricity meters and gas meters in China, we see large upside for smart water meters. The penetration rate of smart water meters increased rapidly during the 13th Five-Year Plan (FYP) period over 2016-2020. But growth of the smart water meter industry slowed notably over 2020-2021 due to the following factors. First, the COVID-19 pandemic hindered sales and installations of water meters, resulting in limited invitation to bids in the smart water meter industry. Second, local governments were planning their water investments in 2021, the first year of the 14th FYP period, and thus there were fewer projects coming on line. Looking ahead, we think tenders in the industry may gradually increase.

Financials and valuation

Considering the high costs of raw materials, we lower our 2022 EPS forecast by 13% to Rmb0.20, and introduce a 2023 EPS forecast of Rmb0.22. The stock is trading at 25.2x 2022e and 22.9x 2023e P/E. We maintain our target price of Rmb5.30. Our TP implies 26.3x 2022e and 23.9x 2023e P/E, offering 4% upside. Maintain OUTPERFORM.

Risks

Tenders in the water meter sector and/or the R&D of new products disappoint.