Runa is a leader in China’s smart heating market. Benefiting from the two prevailing trends of low carbonization and intelligent solutions as well as demand across five key areas, the heating industry may turn around and boast broad market prospects. The intelligent transformation of heating facilities is currently in a rapid development stage, with the penetration rate poised to rise from 1% to 10%. We believe companies with strong hardware and software strengths and one-stop solutions are better- positioned to quickly expand the market by leveraging their higher energy efficiency and customization capabilities. We expect Runa will enhance its long-term growth momentum by constantly enriching product portfolios, developing markets across capital cities, transforming to the asset-light model, putting into production small “lighthouse” factories, and unlocking scale effects. We forecast the Company’s 2023E/24E/25E EPS to be Rmb1.96/2.61/3.48 and derive a 2023E target market cap of Rmb7.9bn based on the combination of absolute and relative valuation methods, corresponding to a target price of Rmb59. We initiate coverage with a "BUY" rating.

AI heating pioneer moving forward on advantages of products, solutions, and services.

Founded in 2008, Runa has a clear three-stage growth path, evolving from a product vendor to a solution provider, and ultimately into a digital heating manager. Its core hardware products, namely, modular heat exchange units and intelligent balance valves, accurately address the pain points of customers, and the software system integrates more than 50 kinds of AI algorithm models in 8 categories. In addition, its energy efficient services allow customers to lower their initial investment. The Company has so far built 7 integrated solutions, acquired 224 patents, and accumulated more than 200 customers. Benefiting from the continuous increase in demand for intelligent & energy-saving heating solutions, Runa recorded operating revenue of Rmb647mn in 2022, up 22% YoY, with attributable net profit (ANP) of Rmb201mn, up 17% YoY. With the continuous enrichment of product lines, expansion of capital city markets and the gradual commissioning of incremental capacity, the Company’s earnings growth may accelerate.

Ushering in the blue ocean market of smart heating.

Industry trend #1: Intelligent transformation of heating facilities is an imperative trend driven by demand on five fronts: the need to replace aging facilities, the goal of energy saving and carbon reduction, saving heating costs, relieving strains on heat sources, and improving residents' comfort.

Trend #2: Emerging information technology empowers city heating systems.

For example, AI empowers smart heating system prediction and decision- making, and digital twin empowers optimized design of smart heating systems, intelligent scheduling and emergency preparedness. According to the essay titled Smart Heating Transformation and Economic Benefit Calculation of Secondary Pipe Network written by Qiu Ning, Zhang Kang, and Ren Yan, heating companies that have adopted smart heating solutions can save 14.8%, 15.0%, and 85.1% of heat consumption, electricity consumption, and water consumption, respectively, and save more than 10% of the comprehensive cost. Under our reasonable assumption that the average unit price of smart heating renovation/new construction is about Rmb30/50 per square meter, we expect the market for smart heating to reach Rmb46.72bn by 2027, implying a CAGR of 27% over 2022-27. The intelligent transformation of heating facilities is undergoing rapid growth, with the penetration rate likely increasing from 1% to 10%. We believe companies with strong hardware and software technology strengths and one-stop solution delivery capabilities are more likely to quickly expand the market with better energy efficiency and customized solutions.

Rapidly expanding capital city markets with the advantages of technology, brand, and manufacturing. 1) Runa has always been technology-oriented, leading the industry in personnel, patents, R&D investment, and technology reserves. In terms of hardware, the Company has a complete presence along the value chain and continues to enrich its product lines. In terms of software, it has 13 core software systems based on operational technology (OT), information technology (IT) and artificial intelligence (AI). By taking full advantage of its accumulated industry data and cooperating with the Flemish Institute for Technological Research (VITO), Runa can effectively reduce carbon emissions of heat companies by 10%-30% and save power consumption by 30%-50%, according to the Company's 2022 annual report. 2) Set more challenging goals: By continuously consolidating its brand advantages and existing customer resources, Runa has started focusing on capital cities and relying on its benchmark status and appeal to achieve a rapid breakthrough in business. 3) Runa has excellent digital capabilities and has self- developed “lighthouse” factories for advanced manufacturing. Based on the project construction plan, the Company will form production capacity of 600 sets of modular heat exchange units and 20,000 sets of intelligent balance valves, equivalent to 2-3 times the existing production capacity.

Through the introduction of information systems such as SAP, product life cycle management (PLM), customer relationship management (CRM), and manufacturing execution systems (MES), the Company realizes full automation, digitalization, and visualization management of equipment and production processes, which ensures the stability and quality of products.

Potential risks: Slower-than-expected industrial policy implementation; Macroeconomic and demand weakness; Seasonal fluctuations in revenue; Product and service innovations falling short of expectations; growing challenges in supply chain management and rising pressures on delivery.

Investment recommendation: Runa is a leader in China’s smart heating market. Benefiting from the two prevailing trends of low carbonization and intelligent solutions as well as demand across five key areas, the heating industry may turn around and boasts broad market prospects. The intelligent transformation of heating facilities is currently in a rapid development stage, with the penetration rate poised to rise from 1% to 10%. We believe companies with strong hardware and software strengths and one-stop solutions are better-positioned to quickly expand the market by leveraging their higher energy efficiency and customization capabilities. We expect Runa will enhance its long-term growth momentum by constantly enriching product portfolios, developing markets across capital cities, transforming to the asset-light model, putting into production small “lighthouse” factories, and unlocking scale effects. We forecast the Company’s 2023E/24E/25E EPS to be Rmb1.96/2.61/3.48. In terms of valuation, we arrive at a target price of Rmb59 by adopting the discounted cashflow (DCF) valuation method, and Rmb59 on 30x 2023E PE under the PE valuation framework considering the average valuation of comparable companies and the Company’s valuation premium. Combining both methods, we initiate coverage with a “BUY” rating and a target price of Rmb59, equivalent to a target market cap of Rmb7.9bn.