Investment positives

We initiate coverage with an OUTPERFORM rating and a target price of Rmb47.25, implying 40x 2023e P/E.

Why an OUTPERFORM rating?

A core ternary precursor supplier to Panasonic and SKI; to benefit from US EV market expansion. Fangyuan Environment became a ternary precursor supplier to Panasonic in 2017 and offered services indirectly to Tesla. In 2020, revenue from Panasonic accounted for around 63% of the total, and the firm is now the second largest ternary precursor supplier of Panasonic. We believe that the production of this automotive part has high environment requirements for production and coordinating with upstream melting companies. Given that China can meet such demands, we expect Panasonic to strengthen cooperation with Chinese ternary precursor suppliers. Thus, we expect Fangyuan Environment to see first-mover advantages. The US is also increasing subsidies for electric vehicles (EV), and we expect this to accelerate the development of EVs in the US. As a main supplier of Panasonic and SK Innovation (SKI), we think that growth at Fangyuan Environment’s will surpass the industry average as we move forward.

Technical strengths, capacity, and potential clients.

Technical strengths: Data from Gaogong Industry Institute (GGII) shows that Fangyuan Environment’s shipment of nickel-rich ternary precursors accounted for more than 95% of its total shipment in 2019, beating most rivals. As one of the first Chinese companies to realize mass production of NCA91 ternary precursors (a nickel cobalt aluminum precursor), the firm maintained its leadership over 2018– 2020 in terms of NCA ternary precursor exports.

Capacity: Fangyuan Environment has around 36,000t ternary precursor capacity at present, and it plans to build 50,000t new capacity. We expect the new project to start operating in early 2022 and bolster precursor sales volume growth.

Clients: Btr New Material Group is the second largest shareholder and customer of Fangyuan Environment, which we think will support the latter’s future sales. The firm also provides nickel cobalt manganese oxide (NCM) precursors to Easpring Material Technology, Shanshan Energy (a subsidiary of Shanshan Corporation), and Tianli Lithium Energy. We expect the portion of NCM in overall shipment to increase steadily given on Fangyuan Environment’s partnership with above companies.

Entry into the capital market to accelerate capacity expansion. Fangyuan Environment’s previous capacity expansion plan was conservative, as a 10,000t ternary precursor project needs an investment of at least Rmb200mn, and the company lacked financing channels. We believe the company could accelerate capacity expansion with the IPO proceeds, bolstering future growth.

How do we differ from the market? We are upbeat on Fangyuan Environment’s cooperation with Panasonic and expect its business to grow rapidly as the US EV market expands. We think it will likely obtain excess returns from its ternary precursor business in the medium term.

Potential catalysts: Accelerating penetration of EVs in the US; smooth customer base expansion for ternary precursor business and incubation of lithium hydroxide (LiOH) business.

Valuation and recommendation

We forecast 2021–2023 EPS at Rmb0.23, Rmb0.68, and Rmb1.17, a CAGR of 126%. The stock is trading at 33.8x 2023x P/E. We value the company at 40x 2023e P/E, implying a target price of Rmb47.25, offering 19.6% upside. We initiate coverage of Fangyuan Environment with an OUTPERFORM rating.

Risks

Disappointing capacity expansion; intensifying competition; sharp rise in raw material prices; overreliance on a single customer; changes in battery technical roadmaps; COVID-19’s impact on overseas business.