Recently, upstream silicon materials and silicon wafers have entered a period of price cuts, which may ease the pressure on the cost side and bode well for the Company to improve the profitability of its photovoltaics (PV) business. In addition, DMEGC Magnetics is accelerating the expansion of the PV business. It recently announced that it plans to invest in a new high-efficiency battery project in Yibin, Sichuan, with an annual output of 20GW in three phases, which may accelerate the growth of its PV business. Overall, DMEGC Magnetics focuses on two industrial groups in development: magnetic materials + devices and PV + lithium batteries, with the new energy business potentially serving as the main contributor to future incremental earnings. We put our 2022E-24E EPS forecasts at Rmb1.01/1.24/1.60. We assign 25x 2023E PE to raise our target price to Rmb30 (vs. Rmb28 previously) and reiterate the "BUY" rating.

Price cuts of upstream silicon materials and wafers will likely benefit downstream battery cell/module manufacturers.

In terms of silicon materials: According to PV InfoLink, the spot price of dense polysilicon dropped by Rmb7/kg to Rmb288/kg during Dec 1-7, down by 2.4% WoW (compared to the price in the week of Nov 24-30). In terms of silicon wafers: The unit price of mainstream 182mm/155μm monocrystalline wafers decreased from Rmb7.11 to Rmb6.95 during Dec 1-7, down by 2.3% WoW.

Looking ahead to 2023, we expect that the price of PV silicon materials will likely continue to trend downwards, and the price reduction at the cost end will also accelerate the installation of battery cells and modules, which will likely boost midstream and downstream earnings along the value chain.

Business overview: With accelerated expansion, its PV/lithium battery revenue may reach Rmb17bn/2.3bn in 2023. 1H22 revenue from the magnetic material/PV/lithium battery/device segment was Rmb2.1bn/5.9bn/800mn/400mn, accounting for 23%/63%/9%/4% of the total, up by 8%/98%/151%/41%YoY, respectively. 1) PV: In the short term, based on the Company’s investor relationship statements, with the European PV module inventory reaching a reasonable level and the resumption of downstream demand, the Company’s PV module shipment in Dec is likely to achieve a significant increase MoM. Meanwhile, the Company expect its shipment to further increase by 20% QoQ in 1Q23. From the perspective of production capacity, the Company’s battery cell/module production capacity can reach 8GW/7GW by the end of 2022. In addition, the Company recently announced its plan to invest in a new high-efficiency battery project with an annual output of 20GW in Yibin, Sichuan, which will be finished in three phases with 6GW/6GW/8GW for the first/second/third phase, respectively.

The first phase of N-type TOPCon products will likely be shipped in 3Q23. We expect the Company's PV business to continue its high growth, and the revenue in 2022/23 will likely reach Rmb12.5bn/17.2bn, up by 92%/38% YoY, respectively. 2) Lithium batteries: The Company’s production capacity of small-power lithium batteries was about 2.5GWh by the end of 2021. It will likely reach 7GWh by the end of 2022 and gradually ramp up to contribute incremental earnings in 2023. In terms of the markets, the Company focuses on electric two-wheelers, portable energy storage, power tools, etc. We expect that with the gradual commissioning of the Company’s new production capacity in 2023-24, small-power lithium batteries will likely maintain a relatively high growth rate, and the revenue may reach Rmb2.3bn/3bn in 2023/24, up by 46%/30% YoY. In addition, the Company is building a presence in the incremental market of household storage via cooperation with players along the value chain. Some of its products are at the stage of certification and testing, and the subsequent progress is worthy of attention.

Valuation analysis: High earnings visibility and underrated valuation. 1) Vertically, we reviewed the PE band of the Company in the past three years and found the upper/lower limit of its PE multiple was about 33x/17x, and the stock is currently trading at about 21x PE (TTM), which is at the 25% quantile in the last three years, implying room for rerating. 2) Horizontally, the Company’s magnetic material, PV, lithium battery, and device business segments will likely contribute 24%, 62%, 8% and 3% to the total revenue in 2022, respectively. Comparable companies we select for each business segment are currently trading at 20x 2023E PE on average, while the Company’s current market cap corresponds to 15x 2023E PE, showing that the Company is relatively undervalued.

Potential risks: The development of the magnetic material industry missing expectations; disappointing downstream prosperity for NEV batteries; PV technology iterations; the capacity expansion of the PV business not up to expectations; the promotion of the device business falling short of expectations; persistent rises in raw material prices.

Investment strategy: DMEGC Magnetics is a domestic magnetic material leader, focusing on two industrial groups in development: magnetic materials + devices and PV + lithium batteries. Considering the continuous capacity expansion of the Company’s PV business in 2023, the sustained high growth of PV modules, and the accelerated commissioning of the small-power lithium battery production capacity, we raise our 2022E/23E/24E net profit forecast to Rmb1.64bn/2.01bn/2.60bn (vs. Rmb1.55bn/1.97bn/2.36bn previously), corresponding to EPS forecast of Rmb1.01/1.24/1.60. Given the historical valuation level of the Company, its PE multiple (TTM) of 25x in the past 3 years, and the average valuation level of comparable companies (20x 2023E PE), and considering the Company’s accelerated capacity expansion of new technologies and products such as TOPcon products, small-power batteries and others, which will likely contribute incremental earnings, we give a certain valuation premium and assign 25x 2023E PE to raise our target price to Rmb30 (vs. our original TP of Rmb28) and reiterate the "BUY" rating.