Core views:

Kaishan Group is the leading screw compressor maker in China. Taking its screw compressor technology as the cornerstone, Kaishan has actively promoted the extension of technology and explored along the value chain. As a result, it has successfully developed organic Rankine cycle (ORC) screw expanders to enter the field of geothermal power generation and has now become a global emerging leader in geothermal power generation. We are optimistic about Kaishan's global strategic footprint. Benchmarking the Company against leading international air compressor companies and considering its strong growth potential in the global geothermal power generation field, we initiate coverage with a “BUY” rating and a target price of Rmb23.

Abstract:

Company profile: A leading screw compressor maker in China and an emerging global leader in geothermal power generation. Kaishan has successfully broken the foreign monopoly through self-developed screw compressors and has gradually grown into a screw compressor leader in China. At present, it has been vigorously promoting a globalized presence and has successively established subsidiaries in North America, Southeast Asia, the Middle East and other regions. Its overseas revenue reached nearly Rmb1bn in 2021, and the revenue proportion of which recorded 45% in 1H22. At the same time, Kaishan has achieved rapid growth in the field of geothermal power generation in recent years through independent R&D of ORC screw expanders and pioneered a new geothermal power generation technology route of "one well, one station", becoming a global emerging leader in this area. The Company's performance posted steady growth. From 2017 to 2021, its revenue increased from Rmb2.221bn to Rmb3.485bn (with a CAGR of 11.9%), attributable net profit (ANP) grew from Rmb104mn to Rmb304mn (with a CAGR of 30.8%) and ex-one-off net profit rose from Rmb96.94mn to Rmb277mn (with a CAGR of 30%).

Compressor business: Kaishan has an extensive product diagram, which is on par with international leaders. 1) Industry prospects: The size of China's air compressor market is growing steadily. According to the forecast of compressor.cn, the market size of China's air compressor is likely to reach Rmb64bn in 2024, corresponding to a CAGR of 3% over 2021-2024, among which screw air compressors are the main products in this segment with the largest market share. 2) Competitive landscape: International companies represented by Atlas and Ingersoll Rand have dominated the high-end market, while domestic manufacturers such as Kaishan, East Asia Machinery and Baosi that have the independent capability of developing and manufacturing screw mainframes have narrowed their gap with international leaders in recent years, alongside the accelerated import substitution. 3) Competitiveness: Kaishan has the most extensive product diagram of compressors among Chinese peers. Screw compressors, as its core products, boast world-leading technologies and product strength. Meanwhile, Kaishan has been vigorously promoting its globalized presence, leveraging its powerful sales network across the world. The operating revenue of Kaishan’s overseas business increased by 80% YoY in 1H22. With the extensive product diagram and the globalized sales capability, Kaishan is on par with international leaders.

Geothermal power generation business: Likely to refuel the growth. 1) Industry prospects: The global geothermal power generation has vast upside potential, and the trend of carbon neutrality drives up the growth of installations. According to the forecast of the Geothermal Energy Association (GEA), the global installations of geothermal power generation will likely reach 18.4GW in 2025, and another 2.5GW will be added during 2022-2025. 2) Competitive landscape: The dual-cycle (binary) power generation technology has become the mainstream, and Ormat dominates the main market. According to Ormat’s annual report, the installations of dual-cycle power generation accounted for 62% of the total geothermal power generation installations in the world during 2017-2021. In the field of dual-cycle power generation, the installations of Ormat, TICA and Kaishan accounted for 78%, 9% and 7%, respectively, of the total. However, from the perspective of project reserves, Kaishan has developed rapidly in recent years. According to the disclosure from the annual reports of Kaishan and Ormat, Kaishan currently has projects under construction of 208.5MW, far outrunning Ormat's about 110MW. 3) Competitiveness: Kaishan has created an original technology route of "one well, one station" meanwhile building a full presence along the value chain of geothermal power generation, from development, construction to operation, with significant advantages in flexibility and cost performance. The T-09 well of the Indonesian (Sorik Marapi geothermal power) SMGP project was completed in Jul 2020, where the duration and costs of drilling have hit the historical best in Indonesia’s geothermal development.

Kaishan's driving force: 1) Overseas business: Kaishan has been vigorously promoting a globalized presence in recent years. Its overseas revenue exceeded Rmb1bn in 2021, and the export revenue of screw air compressors increased by 80% YoY in 1H22, leveraging its strong product competitiveness and cost-effective advantages. 2) Electricity sales business: As Kaishan's geothermal power generation projects are being successively incorporated in the grid for power generation, the high-margin electricity sales business has become a high-growth segment for the Company. In 2021 and 1H22, the electricity sales revenue recorded Rmb256mn (up by 31% YoY) and Rmb206mn (up by 161% YoY), respectively. 3) Geothermal power generation equipment and EPC business: In 2019, Kaishan received an US$65mn order of the engineering, procurement and construction (EPC) project for building a geothermal power station in Kenya. At present, the project has been being smoothly rolled on. With the Company's strong technical know-how and cost advantages, as well as the original "one well, one station" model that has been successfully verified, we expect it to gain a remarkable market share in geothermal power generation equipment and EPC going forward.

Potential risks: A slowdown in the growth of downstream equipment investment due to macroeconomic uncertainties; the global geothermal power generation planning and construction missing expectations; the construction of the Company's geothermal power generation project failing expectations; disappointing financing progress; intensified market competition; fluctuations in exchange rates; the risk of the Company's dependence on core technical personnel.

Investment recommendation: As a leading domestic screw compressor enterprise, Kaishan has been actively promoting the extension of the value chain in recent years. It vigorously ventured into geothermal power generation and has now become a global emerging leader in geothermal power generation. We are optimistic about the Company's strategic globalized expansion, which is on par with leading air compressor players in the world, and it has vast upside potential in geothermal power generation. Based on the above assumptions, we put our 2022E/23E/24E revenue estimates at Rmb3.96bn/5.08bn/6.90bn, with ANP estimates at Rmb0.47bn/0.67bn/1.09bn. Kaishan is currently trading at 42x 2022E PE. Considering the Company's different business growth and models, we use the sum-of-the-parts (SOTP) valuation method. For the compressor business, we select Hanbell Precise Machinery (002158.SZ), whose main business is screw compressors, as a comparable company with 17x 2023E PE based on Wind consensus estimates. Considering Kaishan's leading position and the broader growth headroom of overseas business among its globalized presence, we assign 20x 2023E PE to its compressor business, equivalent to a market cap of Rmb6bn. As for the electricity sales business and the geothermal power generation equipment and EPC business, we select Ormat (ORA.N), the global leader in ORC geothermal power generation, which shares a similar business model with Kaishan, as a comparable company. With Ormat’s five-year-average of 43x PE and Kaishan's business growth as references, we assign 50x 2023E PE to its electricity sales business and the geothermal power generation equipment and EPC business, equivalent to a market cap of Rmb19bn. We give a 90% discount to the SOTP valuation. Based on the above valuations, we arrive at a target price of Rmb23 and initiate coverage with a “BUY” rating.