1H22 results miss our forecast

Sanyuan Biotechnology announced its 1H22 results: Revenue dropped 41.9% YoY to Rmb457mn, and net profit attributable to shareholders declined 50.93% YoY to Rmb119mn (Rmb0.59/sh). Its 1H22 results missed our expectations. The firm's revenue and earnings dropped markedly in 1H22, as: 1) competition intensified after new companies entered the erythritol industry; and 2) prices and sales volume of erythritol notably dropped YoY. In 1H22, gross margin (GM) of erythritol fell 22.4ppt YoY to 18.3%.

In 2Q22, the firm's revenue dropped 64.7% YoY to Rmb185mn (-32.3% QoQ), and attributable net profit declined 67.5% YoY to Rmb56mn (-10.1% QoQ). Its revenue and earnings fell YoY and QoQ in 2Q22 due to decline in prices and sales volume of erythritol. In 2Q22, the firm's GM dropped 26.8ppt YoY to 16.9% (-7.4ppt QoQ).

Trends to watch

Prices and profit of erythritol come under pressure due to intensified competition. Prices of erythritol have declined since 2H21 as new companies enter the erythritol industry and production capacity of this product increases. Baiinfo data shows that the average price of erythritol (in the Shandong market) dropped 17.9% QoQ in 2Q22 to Rmb13,555/t. The price of this product now stands at Rmb11,500/t. Given capacity expansion and intensifying competition, we think prices and profit of erythritol will remain under pressure in the short term. Drops in the earnings of this product will be limited, in our view.

Increased demand will mitigate the impact of capacity expansion, and earnings of erythritol will return to a reasonable level. Medium and long term, we believe demand for erythritol will continue to grow thanks to consumer preference for healthier sugar alternatives, beverage companies expanding to the sugar-free beverages market, and rising use of erythritol in compound sugar. Sanyuan Biotechnology is the world's largest erythritol company, and it has gained a cost advantage. The firm's 50,000t/yr erythritol production project has started trial production. We believe this project will help the company enhance its leading position in the erythritol market.

Rolling out allulose, rebaudioside M, and other new products to improve its product mix. The company has launched compound sugar, rebaudioside M, allulose, and other new products to meet consumer demand. It is building an allulose production project (potential investment: Rmb200mn). This project has been selected as a key project in Shandong in January 2022. In our view, leveraging the company's competitive advantages in production technologies and extensive experience, new products could create a new source of profit growth for Sanyuan Biotechnology.

Financials and valuation

We cut our earnings forecasts 59.5% to Rmb226mn for 2022 and 43.7% to Rmb375mn for 2023 to reflect the decline in erythritol prices and high raw material prices. The stock is trading at 35.2x 2022e and 21.2x 2023e P/E. We maintain an OUTPERFORM rating, but cut our target price 25% to Rmb45 (factoring in bonus shares) due to a lower sector valuation and our lower earnings forecasts. Our TP implies 40.2x 2022e and 24.3x 2023e P/E, offering 14% upside.

Risks

Continued decline in erythritol price and rise in raw material prices; low level of product diversification.