1Q22 results in line with our forecast

Zhenyu Technology announced its 1Q22 results: Revenue rose 145.5% YoY (or 14.3% QoQ) to Rmb1.26bn and net profit attributable to shareholders rose 35.5% YoY (or 6.7% QoQ) to Rmb56mn, while recurring attributable net profit rose 28.89% YoY (or 9.10% QoQ) to Rmb53mn. We attribute the revenue growth to rapid growth of the precision structural parts business.

Trends to watch

Booming alternative-fuel vehicle (AFV) sector boosts ramp-up of LiB structural parts business. Data from the China Passenger Car Association shows that the production, wholesales, and retail sales volume of passenger vehicles were 5.36mn, 5.44mn, and 4.92mn units in 1Q22, with YoY growth of 11.0%, 8.3%, and -4.5%. Specifically, the wholesale volume of alternative-fuel passenger vehicles surged 145.4% YoY to 1.19mn units, a penetration rate of 22%. We think CATL, one of the firm’s largest clients, contributed a large portion of the firm’s lithium battery structural parts orders. Data from the China Battery Union shows that the installation price of structural parts supplied to CATL stood at Rmb40mn/GWh. Assuming the proportion of business and order contribution from CATL remained flat vs. 2021, we estimate the proportion of CATL’s LiB structural parts purchased from Zhenyu Technology rose to 65.1% in 1Q22 from 49.5% in 2021.

Adjustments in business structure weigh on gross margin; efforts to reduce costs and enhance efficiency pay off. In 1Q22, the proportion of revenue from the precision structural parts business increased. This, combined with higher raw material prices, weighed on the firm’s gross margin. In 1Q22, the firm’s gross margin declined 9.2ppt YoY to 13.9%, down 2.0ppt QoQ. The firm’s efforts to reduce costs and enhance efficiency paid off, which drove up profitability. In 1Q22, expense ratio dropped 4.9ppt YoY to 8.2%, down 0.6ppt QoQ, with G&A expense ratio dropping 3.3ppt YoY or 0.7ppt QoQ to 2.7%. Thanks to improved operating capacity the decline in the firm’s attributable net margin narrowed markedly compared with that of gross margin. Net margin dropped 3.6ppt YoY or 0.3ppt QoQ to 4.5% in 1Q22.

Upbeat on long-term growth of LiB structural parts business; watch earnings growth. In terms of demand, the firm has built close ties with CATL, with the order contribution from CATL continuing to rise. In 2022, we think orders from CATL for the firm’s structural parts will increase sharply, driven by soaring demand for LiB and faster capacity expansion at CATL. In terms of cost, prices of silicon steel sheets, copper, and plastic have stabilized since early 2022, and the rise of aluminum prices has notably narrowed. We think the firm’s profit margin will improve notably in 2022, driven by the growing scale of the LiB structural parts business, a higher market share, stronger economies of scale, and a marginal easing of raw material price hikes. We are upbeat on the firm’s overall earnings growth.

Financials and valuation

We leave our 2022 and 2023 earnings forecasts unchanged. The stock is trading at 21.7x 2022e and 13.5x 2023e P/E. We maintain OUTPERFORM and our target price of Rmb120, implying 29.5x 2022e and 18.4x 2023e P/E, offering 36.2% upside.

Risks

Raw material prices continue to rise; disappointing expansion of LiB structural parts and motor cores businesses.