Investment positives

We initiate our coverage on Sanyuan Biotechnology with an OUTPERFORM rating and target price of Rmb120, implying 23.1x 2022e and 19.5x 2023e P/E.

Why OUTPERFORM rating?

The world’s largest producer of erythritol: In 2020, Sanyuan Biotechnology accounted for 39% of global and 56% of China’s erythritol production. The firm has launched compound sugars including erythritol and monk fruit, stevia, and sucralose, and has developed new products such as rebaudioside M and allulose, aiming to increase product categories and create new growth drivers.

Erythritol production capacity expanding driven by rapid demand growth: Demand for erythritol continues to grow rapidly, thanks to consumers’ preference for healthier sugar alternatives, beverage companies expanding to sugar-free beverages market, and rising use of erythritol in compound sugar. In 2020, China’s demand for erythritol reached 41,000t, implying a CAGR of 101% over 2016-2020. According to Frost & Sullivan, by 2025 global demand for erythritol may reach 489,000t, and 285,000t in China, implying CAGR of 26% and 34% in 2021-2025. In 2020, China accounted for 70% of global erythritol production. China’s leading producers have expanded production capacity aggressively to meet rapidly growing demand. We expect the price of erythritol to return to a reasonable level thanks to the rising number of new producers.

Firm leveraging on its cost advantages to expand production capacity and solidify its leading position: Gross margin of the firm’s erythritol business is much higher than those of competitors thanks to its advantaged production process and lower unit energy consumption. The company plans to build new erythritol production capacity of 50,000t, which may serve as additional growth driver. We expect the firm to further solidify its leading position.

How do we differ from the market? The market is concerned that profitability of the erythritol business may decline as a result of intensifying market competition. However, we believe it will take time for competitors to catch up with Sanyuan Biotechnology. We believe production capacity expansion will continue to drive rapid earnings growth.

Potential catalysts: Increased range and sales volume of sugar-free beverages drive rapid growth of erythritol demand.

Financials and valuation

Our EPS forecast is Rmb3.89 in 2021, Rmb5.19 in 2022, and Rmb6.15 in 2023, a CAGR of 26%. The stock is trading at 17.6x 2022e and 14.8x 2023e P/E. We initiate our coverage on Sanyuan Biotechnology with an OUTPERFORM rating and target price of Rmb120 (23.1x 2022e and 19.5x 2023e P/E), offering 31% upside.

Risks

Declining erythritol prices; rising price of glucose; renminbi appreciation; overreliance on individual products.