1H23 results missed our expectations Sobute New Materials announced its 1H23 results: Revenue fell 5% YoY to Rmb1.66bn, and attributable net profit dropped 41% YoY to Rmb96.99mn. In 2Q23, revenue fell 4% YoY to Rmb995mn, and attributable net profit dropped 33% YoY to Rmb56.57mn. The firm's 1H23 results missed our expectations, mainly due to slower-than-expected demand recovery, which resulted in disappointing cost and expense dilution.

Downstream demand recovery is relatively weak, and sales volume still faces downward pressure YoY. The sales volume of high- performance water-reducing admixtures and functional materials fell 5.8% and 8.1% YoY to about 484,800t and 109,000t in 1H23. In 2Q23, they fell 6.3% and 13.2% YoY to about 296,500t and 63,200t, with declines for both widening from 1Q23, indicating that sales recovery faced headwinds amid weakening demand in 2Q23.

Prices remained stable, and revenue declined. In 1H23, the ASP of high-performance water-reducing admixtures fell 5% YoY, while that of functional materials rose 3% YoY, largely stable. Revenue from these two products fell 11% and 5% YoY due to sales volume and price fluctuations.

On the cost side, raw material prices fell, but the dilution effect weakened, and GM increased YoY in 2Q23. The ASP of ethylene oxide fell 19% YoY in 2Q23, allowing the firm to reduce raw material costs.

However, GM improved mildly by 1.8ppt to 35% in 2Q23, as new capacity was still ramping up at the base in southern China, and cost dilution declined due to shrinking sales volume. Expense ratios rose YoY. In 2Q23, selling and G&A expense ratios rose 4.4ppt and 0.9ppt YoY to 12.2% and 7.3%, and the financial expense ratio fell 0.2ppt YoY to 1.1%.

The testing business performed steadily; operating cash flow fell. In

1H23, testing centers' revenue and net profit both grew around 8% YoY to Rmb348mn and Rmb76.62mn, remaining solid despite a weak environment. However, testing centers' net operating cash flow fell Rmb24.62mn YoY to Rmb37.65mn in 1H23, dragging the firm's net operating cash flow in 1H23.

Trends to watch

Demand to recover mildly; Sobute has increased efforts to develop infrastructure projects; we see large growth potential in functional materials. As pro-growth policies take effect, we expect demand for residential-use admixtures to gradually recover and demand to recover mildly.

In 1H23, the firm increased efforts in developing infrastructure projects and participated in the construction of many key national and local projects. The proportion of revenue from infrastructure business may increase. We think the firm's key functional material products (transportation materials and anti-cracking materials, most of which are for infrastructure construction) could benefit significantly as the physical workload growth of infrastructure construction accelerates, and experience significant growth potential.

Financials and valuation

As we lower our assumptions for sales volume and unit earnings, we lower our 2023 and 2024 attributable net profit forecasts 52.8% and 55.2% to Rmb209mn and Rmb241mn. The stock is trading at 25.5x 2023e and 22.1x 2024e P/E. With the downward revision smaller than our earnings revisions, as the sector may recover from the bottom, we maintain OUTPERFORM and cut our TP 28.6% to Rmb15, implying 30.2x 2023e and 26.1x 2024e P/E, and implying 18% upside.

Risks

Demand recovery and/or cost and expense dilution disappoint.