Initial Coverage

Investment positives

We initiate coverage of Fangyuan Environment with an OUTPERFORM　rating and a target price of Rmb47.25.

Why an OUTPERFORM rating?

A core ternary precursor supplier to Panasonic and SKI; poised to benefit from US EV market expansion. Fangyuan Environment became　a ternary precursor supplier to Panasonic in 2017, and it offers services indirectly to Tesla. In 2020, revenue from Panasonic accounted for around 63% of the company’s total; it is now the second-largest ternary precursor supplier of Panasonic. We believe 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, Fangyuan Environment should benefit from first-mover advantage, in our opinion. 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), Fangyuan Environment’s growth likely will surpass the industry average in the future, in our view.

Technical strengths, capacity, and potential customers

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 -peers. Among the first Chinese companies to realize mass production of NCA91 ternary precursors (a nickel cobalt aluminum precursor), the company was the leader over 2018-2020 in lithium nickel-cobalt-aluminum oxide (NCA) ternary precursor exports.

Capacity: The company has about 36,000t ternary precursor capacity at present. Plans to build new capacity in a 50,000t/yr high-end ternary precursor (NCA and NCM) project should come onstream in early 2022, bolstering precursor sales volume growth, in our opinion.

Customers: Btr New Material Group is the second-largest shareholder and customer of Fangyuan Environment, likely supporting its future sales.The company provides nickel cobalt manganese oxide (NCM) precursors to Easpring Material Technology, Shanshan Energy, and Tianli Lithium Energy. We expect the portion of NCM in overall shipment to increase steadily given Fangyuan Environment’s partnership with these companies.

Entry into the capital market to accelerate capacity expansion. The　company plans to invest its IPO proceeds into a 50,000t/yr high-end ternary precursor (NCA and NCM) project and a 10,000t LiOH project. The LiOH project can reduce the company’s reliance on primary ore minerals efficiently and protect metal resources, in our view.

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 realize 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 its 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. Using the comparable company valuation methodology, we assign a valuation of 40x 2023e P/E, implying a target price of Rmb47.25 and 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.