1H22 results in line with our forecast

LinControl Automotive Electronics announced its 1H22 results: Revenue fell 15.0% YoY to Rmb361mn, attributable net profit dropped 26.0% YoY to Rmb59mn, and recurring net profit declined 38.68% YoY to Rmb43mn. The firm’s 2Q22 revenue fell 15.5% YoY but grew 11.0% QoQ to Rmb190mn, attributable net profit dropped 25.9% YoY but rose 24.2% QoQ to Rmb32mn, and recurring net profit fell 27.6% YoY but increased 44.4% QoQ to Rmb25mn. The firm’s results were in line with our forecasts.

Trends to watch

Revenue and earnings outperform peers; rapid growth in non-road mobile machinery market improving profitability. Data from China Association of Automobile Manufacturers (CAAM) shows that domestic sales volume of commercial vehicles fell 41.1% YoY in 1H22 due to COVID-19 resurgence and slow launch of infrastructure projects. We believe this has imposed an impact on sales of the firm's engine management systems (EMS) products. The firm’s 1H22 revenue fell 15.0% YoY, and attributable net profit excluding share payments rose 7.9% YoY to Rmb85mn. Gross margin (GM) and attributable net profit margin excluding share payments grew 13.5ppt and 6.7ppt YoY to 43.0% and 25.3%.

The firm’s revenue and earnings outperformed peers and increased QoQ, with profitability improving significantly. We attribute this to the following factors. 1) The firm’s product structure changed, and sales proportion of high-GM electronic control unit (ECU) products (meeting the China IV and V emission standards) increased. 2) Client structure improved as higher-GM new clients were added to the client base.3) Revenue contribution from high-GM technology development rose YoY.

Increasing R&D investment to boost long-term growth momentum amid business transformation and upgrading. The firm’s 1H22 R&D expense ratio rose 15.7ppt YoY to 23.7%, as: 1) the firm invested significantly in the development of new technologies such as electronic control systems for gasoline direct injection (GDI) passenger vehicles and hybrid vehicles, as well as vehicle control units (VCU) and motor control units (MCU) for all-electric vehicles. The number of R&D staff increased 76.9% YoY to 598, representing 74.1% of the total number of the firm’s staff. 2) In order to motivate its core technical staff, the firm implemented its 2021 equity incentive plan, and charged provisions for share payments. We believe that the early stages of software development will see limited returns with large investments, whereas the return may significantly increase as the technology matures. The firm is preparing for the mass production of products for GDI passenger vehicles and hybrid vehicles, and it has obtained a number of new orders for designated products. We expect the firm’s new businesses to ramp up.

Plans to acquire an oil atomizer production line to enhance presence in value chain and further consolidate competitive advantages in EMS products. In May 2022, the firm announced a plan to obtain a non-exclusive license in China for passenger vehicle and light-duty truck related intellectual property rights and proprietary technologies from Vitesco Technologies GmbH and its related party Vitesco Automotive. It also plans to purchase an oil atomizer production line of Vitesco Automotive. We believe that the acquisition will help the firm enhance its technologies, improve the stability of the supply chain, and reduce procurement costs, thereby consolidating the overall competitive advantage of the firm’s EMS business.

Financials and valuation

We maintain our 2022 and 2023 earnings forecasts. The stock is trading at 32.2x 2022e and 18.3x 2023e P/E. We maintain OUTPERFORM and a TP of Rmb130, implying 33.8x 2022e and 19.2x 2023e P/E with 4.8% upside.

Risks

Overly concentrated customer structure; accelerated replacement of gasoline EMS amid trend toward electric vehicles; declining operating cash flow; growing inventories; issues with chip procurement; impairments of accounts receivable.