Due to the impact of the local pandemic in Shanghai, Mingzhi Technology's operating revenue and attributable net profit (ANP) in 1H22 have decreased, and the gross profit margin (GPM) was affected by the high overall costs. We are optimistic about the two-wheel drive of Mingzhi's equipment and castings businesses, which are likely to accelerate the operating revenue growth. We expect the CAGR of the Company’s earnings to be 30% in the next three years. With comparable companies as a reference, we assign 25x 2023E PE to raise the target price to Rmb41 from Rmb34 and reiterate the "BUY" rating.

Earnings and revenue declined, dragged by the local pandemic in 1H22, in line with expectations.

In 1H22, Mingzhi recorded operating revenue/ANP/ex-one-off ANP of Rmb282mn/6mn/-6mn (-11.4%/-86.7%/-114.1% YoY), in line with expectations. In our view, the decline in the 1H22 operating revenue was mainly due to the pandemic in Shanghai that hindered its business development, product delivery, and equipment installation & debugging. The ANP decline mainly resulted from decreased GPM and the sharp rise in R&D expenses. With the ease of the pandemic, the forthcoming peak season of wall-hung boiler heat exchangers, and the acceleration of project income recognition, the Company's operating revenue is likely to resume rapid growth in 2H22.

The rising costs of raw materials, accessories, manpower, and logistics exerted pressure on the GPM, which decreased by 9.71ppts YoY in 1H22.

The overall GPM was 26.24% (-9.71ppts YoY), of which the GPM for casting products was 21.0% (-11.0ppts YoY), and the GPM of equipment was 40.2% (-6.7ppts YoY), mainly due to the rising overall costs of raw materials, accessories, manpower, and logistics. Some unconfirmed income caused the equipment and casting business expenses to be accrued in advance, which also led to a decrease in the overall profit margin. The Company's 1H22 selling/administrative/R&D/financial expense ratios changed by -0.70/+2.27/+6.17/-0.23ppts YoY. R&D expenses increased by 105% YoY, mainly invested in the R&D projects such as intelligent quick casting (QC) systems and high-performance lightweight aluminum alloy casting research.

With the landing of R&D projects, and the downward prices of raw material, logistics and manpower costs, the Company's earnings are likely to increase.

Repurchase of shares boosts investors’ confidence, and a number of R&D projects are likely to contribute to revenue in the next two years.

On May 28, 2022, the Company announced to repurchase shares of Rmb30mn-60mn via centralized price bidding, which will be used for employee stock ownership plans or equity incentive plans to boost investors’ confidence. A number of its research projects are expected to be delivered, including intelligent QC systems, high-performance casting, large thin-walled aluminum alloy casting, new energy vehicle lightweight chassis parts, and sand-core and core-making equipment for big or oversized marine engine cylinders. We expect them to substantially improve the income in the next two years.

Potential risks: Competition in the global core-making equipment market intensifies; customer expansion disappoints; raw material prices fluctuate.

Investment recommendation: Due to the impact of the local pandemic in Shanghai, the Company's 1H22 operating revenue and ANP both declined, and the high overall costs affected the GPM. Thus, we revise the profit forecasts for 2023E-2024E and lower the 2022E earnings forecast. Since several R&D projects are likely to contribute to the revenue in the future, we raise our 2023E/24E EPS forecasts to Rmb1.63/2.22 from Rmb1.56/2.14 and revise 2022E EPS forecast to Rmb0.80 from Rmb1.14, corresponding to 39.2x/19.2x/14.1x 2022E/23E/24E PE at the current stock price. We are optimistic about the two-wheel drive of the Company's equipment and castings businesses, which will likely to accelerate the operating revenue growth (the earnings CAGR estimated at 30% in the next three years). Considering the average Wind consensus valuation of 30x 2023E PE for comparable companies (Envicool (002837), Canatal (603912) and Shenling (301018)), the relatively low business certainty of the Company, and the long revenue recognition period of the equipment business, we assign 25x 2023E PE to raise the target price to Rmb41 from Rmb34 and reiterate the "BUY" rating.