Investment positives

We initiate coverage of Holystar Information Technology Co., Ltd. (Holystar) with an OUTPERFORM rating and a TP of Rmb127.68 (25x 2022e P/E).

Why an OUTPERFORM rating?

Primary and secondary integration equipment sector: Penetration rate to rise; upbeat on booming sector. As an economy develops, power distribution networks require highly reliable, high-quality power supply that is largely enabled by monitoring of distribution network status, and fault location and isolation. Primary and secondary integration equipment has notable advantages for the internet of things (IoT), smart features and compatibility. In our opinion, incremental and replacement demand for this product is sizable, and the penetration rate of primary and secondary integration equipment will increase. For instance, primary and secondary integration circuit breakers for smart poles accounted for 79.3% of all tenders for circuit breakers for smart poles in 2021 (vs. 35.7% in 2018). We estimate that demand for primary and secondary integration circuit breakers for smart poles will reach nearly 0.8mn units in 2025. Technology standards for this product and the magnitude of integration will continue to improve, in our view.

Holystar: A leading primary and secondary integration switch firm focusing on high-end market, with market-leading technology and first-mover advantages. In the early stage, Holystar has laid a solid foundation in fault detection and diagnosis capabilities. Due to the competitive advantages resulting from its experienced and capable management and R&D teams, the firm has gained a deep understanding of State Grid's requirements. Holystar’s switches for smart poles are well suited for IoT, smart features and integration due to the firm's improving technologies over the past decade. Holystar focuses on the high-end market. Gross margin (GM) of its switches for smart poles exceeds 50%, while GM of traditional pole switches provided by other companies stands at around 20-30%. Sales volume of Holystar's switches for smart poles has increased rapidly since it launched the product in 2016. We estimate that sales volume of this product exceeded 20,000 units in 2020 and 26,000 units in 2021. We believe Holystar has a first-mover advantage due to its data, experience, and customer recognition for its products.

Holystar continues to grow rapidly thanks to its efforts to expand beyond Zhejiang and to add product lines. Sales volume of the firm's switches for smart poles has increased rapidly after a 4-year project in Zhejiang province. We expect Holystar to rapidly expand outside Zhejiang following the success of the State Grid Zhejiang project. As the firm improves its marketing service network, we think that sales volume will gradually increase in Jiangsu, Fujian, Henan and Shandong. In addition to high-voltage, Beidou and 5G telecommunication switches for smart poles, Holystar is also developing primary and secondary integration ring main cabinets and other new products. These new products are either at the pilot stage or at the mass-production stage. Holystar is developing a primary and secondary integration platform in order to expand its presence in new markets.

How do we differ from the market　　The market pays close attention to the track record and high earnings of Holystar's switches for smart poles, while we analyze the sustainability of the firm's rapid growth and high earnings from the perspectives of industry demand and the firm's core competitive advantages.

Potential catalysts: State Grid imposes higher standards on primary and secondary integration technologies; Holystar accelerates its move to expand its presence outside Zhejiang; the firm's efforts to roll out new products proceed smoothly.

Valuation and recommendation

We estimate the firm's 2021, 2022 and 2023 EPS at Rmb4.11, Rmb5.11 and Rmb6.46, a CAGR of 25.4%. We think that the penetration rate of primary and secondary integration equipment will increase markedly, as this product can meet demand from smart power grids and active distribution networks. Holystar has gained advantages in technology and distribution channels. Its platform strategy should help the firm expand its presence in new markets with little competition. We are upbeat on its growth potential. We initiate coverage of Holystar with an OUTPERFORM rating, a target market cap of Rmb12.8bn, and a TP of Rmb127.68. The stock is trading at 21x 2022e P/E. Our TP implies 25x 2022e P/E, offering 19.8% upside.

Risks

Lower-than-expected power grid investment; excess reliance on several clients; fiercer competition.