1Q22 earnings slightly beat our expectation

Holystar Information Technology announced its 1Q22 results: Revenue grew 47.57% YoY to Rmb294mn, and net profit attributable to shareholders rose 61.32% YoY to Rmb113mn. Holystar’s efforts to explore markets in other provinces are paying off, and its sales of switches for smart poles have increased substantially. The company’s 1Q22 earnings slightly beat our expectation.

Trends to watch

Efforts to explore markets of switches for smart poles in other provinces paying off; 1Q22 revenue up 47.57% YoY. In recent years, in addition to strengthening its presence in the Zhejiang market, Holystar has continuously strengthened its marketing service network. In 2021, the company made breakthroughs in the Jiangsu, Shaanxi, Fujian, Shanxi, Shandong, and Henan markets. Its sales volume of switches for smart poles grew 13.58% YoY to about 23,500 units in 2021, and we estimate that Zhejiang, Jiangsu, and other provinces accounted for about 50%, about 40%, and about 10% of the sales volume. The company has quickly made a breakthrough in the Jiangsu market thanks to the demonstration effect in the Zhejiang market. We estimate that Jiangsu accounted for nearly 60% of the company’s sales volume of switches for smart poles in 1Q22. We believe that the company’s businesses have sufficient room for growth in the Zhejiang and Jiangsu markets. About 0.26mn units of traditional switches still need to be replaced in Zhejiang. Meanwhile, based on local electricity consumption, we expect 0.42mn units of switches for smart poles to be installed in Jiangsu (30% higher than that in Zhejiang). We think the Jiangsu market has promising growth potential. In addition, the company is expanding distribution channels in key markets such as Shaanxi and Shandong, and we are optimistic that the company may accelerate its expansion in the national market thanks to its competitive products.

Products shipped as of end-2021 indicate strong demand and orders; optimistic about 1H22 earnings. As of end-2021, the company’s products that had been shipped but not been installed (mainly switches for smart poles that had been shipped but not been installed) had a total value of Rmb365mn, up 83.15% YoY. We think this not only indicates strong demand and orders in 2021, but also has greatly reduced some risks for the company (e.g., delays in logistics caused by the COVID-19 pandemic). The installation of switches for smart poles generally takes less than 6 months, and there is a strong correlation between the value of the company’s products shipped as of the end of a year and the operating cost in the first half of the next year. We assume that 95% of the shipped products are installed and the company recognizes revenue from these products within 6 months, and that the gross profit margin of these products is 52%. If so, we expect the company to generate revenue of about Rmb720mn in 1H22, implying 53% YoY growth and equivalent to 64% of full-year revenue in 2021.

Profitability roughly stable in 1Q22; operational efficiency improving steadily. In 1Q22, the company’s gross profit margin fell 3.35ppt YoY but rose 6.92ppt QoQ to 52.76%. Its overall expense ratio dropped 6.34ppt YoY to 11.35% with selling expense ratio falling 1.75ppt YoY, G&A expense ratio falling 2.18ppt YoY, financial expense ratio rising 0.03ppt YoY, and R&D expense ratio declining 2.44ppt YoY. The company’s net profit margin rose 3.27ppt YoY and 13.90ppt QoQ to 38.40%.

Financials and valuation

As the company’s efforts to explore markets and improve operational efficiency slightly beat expectations, we raise our 2022 and 2023 net profit forecasts by 5% and 3% to Rmb535mn and Rmb667mn. The stock is trading at 17.5x 2022e and 14.0x 2023e P/E. We maintain OUTPERFORM rating and our TP of Rmb127.68 (23.9x 2022e and 19.1x 2023e P/E), offering 36.37% upside.

Risks

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