Film capacitors boast outstanding advantages in the new energy sector, which in turn will continuously lead the development of the film capacitor industry. Meanwhile, the expansion of ultra-thin polypropylene (PP) films is limited by the supply of production equipment. Coupled with the rising penetration rate of new energy applications and the improving industrialization of composite copper foil, the gap between supply and demand may widen in the future. As a manufacturer with abundant technical reserves, leading base film production capacity, and an integrated presence along the industry chain, Tongfeng Electronics will usher in future growth driven mainly by the release of film capacitor capacity and price increase of ultra-thin PP film from the widening supply- demand gap. We expect the Company’s 2022E/23E/24E attributable net profit (ANP) to be Rmb830mn/119mn/166mn, up 62.64%/44.23%/39.19% YoY, respectively. Based on the valuation of comparable companies and our earnings growth forecasts, we put its market cap at Rmb5bn in 2023, corresponding to a target price of Rmb8.9. We initiate coverage with a “BUY” rating.

Changes in shareholding structure and reform on shifting focus to the main business starting a new chapter for Tongfeng Electronics.

Founded in 1952, Tongfeng Electronics shifted its business to electronics production in 1975. At present, the Company mainly engages in the R&D, production and marketing of the film capacitors and film materials. During its development, the shareholding structure underwent two major changes, one of which was Tongling Dajiang Investment becoming the Company’s controlling shareholder through investment in 2020. Since then, Tongfeng experienced profound reforms, including conducting general elections for the board of directors and the supervisory board in advance, appointing new management team, improving the Company’s regulation system, strengthening the internal control system, and writing off a number of subsidiaries with no operating value. It also promoted the optimization of its product structure, market coverage and customer expansion, and invested in multiple new projects related to its main business, achieving the results of shifting focus to its main business.

Film capacitors standing out in new energy field and injecting new momentum to the development of new wind and PV industries.

Film capacitors present advantages of high withstand voltage, long life, good temperature characteristics and sound self-healing ability, which have strong capability to extend to the downstream links. At present, their applications have expanded from traditional fields, such as home appliances and lighting, to new energy fields, including smart grids, microelectronic systems, new energy vehicles (NEVs), photovoltaics (PV) power & wind power and so on.

In 2020, nearly half of the film capacitors were applied in the fields of PV & wind power. The development of new energies will inject continuous momentum into the growth of film capacitors as the market demand brought by PV & wind power/NEVs will achieve an over 25%/27% CAGR in 2022-25 based on our estimates.

Limited capacity expansion of ultra-thin film by the equipment may widen the future supply-demand gap.

Base films are the main raw material of film capacitors, accounting for 60%- 70% of the raw material costs. The quality of the base films directly determines the products’ capacitance stability, withstand voltage, insulation resistance, safety, duration and other parameters, meaning that the base films are the key material to the film capacitors. As base film production equipment requires high standard technical index, most of them are customized with a long delivery period. In addition, the trend of ultra-thin and heat-resistant capacitors raises the barriers to entry. Currently, ultra-thin PP films are in short supply. Coupled with the strong demand from new energy and other fields which are not able to be fulfilled by the capacity planning of the mainstream manufactures, the supply-demand gap may be further widened in the future.

Abundant technology reserve, leading base film production capacity and integration consolidating the competitive advantages.

Tongfeng has established cooperative relationships with well-known enterprises at home and abroad backed by its profound technical advantages. Currently, it has 6 PP base film production lines with ~15kt of capacity (two under construction with capacity of ~4.1kt), taking the lead in the industry. The Company formed an integrated production model of biaxially oriented films, metallized film and film capacitors in 1990. Through years of development, the Company consolidates its advantages of value chain integration, which is conducive to the mutual support of upstream and downstream product technologies and cost advantages.

Riding the clear trend of composite copper foil industrialization, Tongfeng may benefit from the industry-leading ultra-thin PP capacity.

Composite copper foil is a good alternative to traditional foil with its attributes of safety, applicability and good value for money, and its trend of industrialization is very clear. At present, polyethylene terephthalate (PET) and PP are the main choices of base films, with PET industry advancing at a leading pace and PP progressing slightly slower due to its technology challenges. However, as technical problems are gradually solved, the penetration rate of PP may gradually increase. Under the neutral assumption, we estimate that by 2025, the composite copper foils will add ~10kt of ultra- thin PP film demand, which will further widen the supply-demand gap of ultra- thin PP film and is likely to stimulate price increase.

Potential risks:

Operation affected by macroeconomic fluctuations; profitability downside due to intensified competition; price fluctuations of raw materials; lower-than- expected penetration rate of the PP copper composite foils; inventory impairment risks.

Investment strategy:

Tongfeng’s future growth momentum mainly comes from the release of production capacity and the widening of the supply-demand gap: 1) The Company has expanded several film capacitor projects after the shareholding structure change in 2020. which will likely enter the harvest period; 2) Currently, the ultra-thin PP films are in tight supply. With the continuous promotion of the industrialization, the supply-demand gap is likely to further widen in the future. As a leading manufacturer with ultra-thin PP film capacity, the Company will likely be the first to benefit from this trend. We expect the Company’s 2022E/23E/24E ANP to be Rmb830mn/119mn/166mn (up　62.64%/44.23%/39.19% YoY), implying EPS forecasts of Rmb0.15/0.21/0.29, respectively. Based on the valuation of comparable companies and our earnings growth forecasts, we put its market cap at Rmb5bn in 2023, corresponding to a target price of Rmb8.9. We initiate coverage with a “BUY” rating.