2023 and 1Q24 results miss our expectations

Sobute New Materials announced its 2023 results: Revenue fell 3.6% YoY to Rmb3.58bn and net profit attributable to shareholders declined 44.3% YoY to Rmb160mn. In 4Q23, revenue rose 0.6% YoY to Rmb1.01bn, and net profit attributable to shareholders fell 64.0% YoY to Rmb18.98mn. The firm's 2023 results miss our expectations due to rising expense ratios and higher-than-expected impairment provisions.

The company announced its 1Q24 results: Revenue fell 13.1% YoY to Rmb579mn and net profit attributable to shareholders dropped 47.8% YoY to Rmb21.09mn. The firm's 1Q24 results miss our expectations, as downward pressure on demand was sharper than we expected.

2023: Full-year sales volume under pressure; ASPs trended downward. In 2023, the firm’s sales volume of high-performance water- reducing admixtures (WRA), high-efficiency WRA, and functional materials changed -8%, +10%, and -6% YoY to 1.02mnt, 51,000t, and 269,000t, with ASPs changing -4.7%, -4.5%, and +10.0% YoY. Gross margin recovered slightly. In 2023, the firm's blended gross margin rose 0.8ppt YoY to 34.3%, with gross margin of functional materials up 1.29ppt YoY. Expense ratios rose. In 2023, the firm's selling, G&A and R&D expense ratios grew 0.8ppt, 1.4ppt, and 0.5ppt YoY 10.5%, 8.5% and 6.0%; and financial expense ratio was largely flat YoY at 1.4%.

Impairment provision weighed on profit. In 2023, the firm made Rmb67.76mn of provisions for credit impairment losses and Rmb4.88mn of provisions for asset impairment losses, which weighed heavily on earnings in the year. Cash flow remained strong; dividend payout ratio fell slightly. The firm's net operating cash flow increased 68.8% YoY to about Rmb370mn in 2023, and dividend payout ratio fell 3.3ppt YoY to about 40.47%. Technology service business maintained steady growth. In 2023, revenue of the firm's technology service business rose 12.2% YoY, and gross margin grew 1.0ppt YoY, indicating steady growth.

1Q24: Prices of high-performance WRA still faced significant downward pressure. In 1Q24, sales volume of high-performance WRA slid 15.8% YoY and ASP fell 10.4% YoY, still facing downward pressure; sales volume of functional materials remained largely flat YoY, with ASP rising 13.6% YoY and 30.7% QoQ.

Trends to watch

It may still take time for downward pressure on demand to ease; we think the firm’s impairment risk is manageable after making prudent provisions. Based on the firm's sales volume in 1Q24, we estimate that the downward pressure on downstream demand may still take some time to ease, and the firm's YoY sales volume recovery is yet to come. However, as the firm has prudently made provisions for potential risks in 2023, and about Rmb27.32mn of credit impairment losses were written back in 1Q24, we believe its impairment risk is manageable.

Financials and valuation

Due to sharper-than-expected downward pressure on demand, we lower our 2024 attributable net profit forecast 37.7% to Rmb150mn and introduce 2025 attributable net profit forecast at Rmb171mn. The stock is trading at 23.4x 2024e and 20.5x 2025e P/E. We maintain an OUTPERFORM rating and cut our target price 32.7% to Rmb10.1, implying 29.1x 2024e and 25.6x 2025e P/E with 24.7% upside.

Risks

Demand recovery disappoints; impairment pressure worse than expected.