2023 result largely in line; 1Q24 slightly missing our expectations

Luyang Energy-Saving Materials announced its 2023 and 1Q24 results. In 2023, revenue fell 1.85% YoY to Rmb3.52bn, attributable net profit fell 15.7% YoY to Rmb492mn, and recurring net profit dropped 5% YoY to Rmb523mn, which was largely in line with our expectations. In 1Q24, revenue fell 7.3% YoY to Rmb701mn, attributable net profit dropped 4.6% YoY to Rmb82.46mn, and recurring net profit fell 16% YoY to Rmb81.97mn, slightly missing our expectations due to lower-than- expected revenue growth.

2023: Ceramic fiber sales volume grew steadily; profit per tonne fell slightly. In 2023, the firm's sales volume of ceramic fiber rose 8% YoY to 540,000t, but the ASP fell 3% YoY to Rmb5,819/t due to structural changes and market competition, implying that revenue from ceramic fiber rose 4% YoY to Rmb3.1bn. GM fell 0.4ppt YoY to 34.1%. New business contributed revenue but booked losses. In 2023, the company acquired Gutsche Textile Engineering (industrial filtration) and Unifrax (Shanghai) (auto pad) from its large stakeholder, which contributed revenue of Rmb142mn and Rmb220mn. However, their GMs were only 6.7% and 8.1%, and they contributed Rmb34.58mn of net loss in 2023.

Expenses rose after M&A. The firm's expense ratio rose 1.8ppt YoY to 15.1% due to M&A, with selling and G&A expenses rising 25% and 8.2% while R&D expenses falling 3.8% YoY. Net margin fell slightly. Net margin dropped 2.3ppt YoY to 14% in 2023 (recurring net margin down 0.4ppt YoY to 14.9%) dragged by newly merged companies. Cash flow slightly under pressure. The cash-to-revenue ratio remained largely flat YoY at 89% in 2023, but operating cash flow fell Rmb284mn (or 49%) YoY to Rmb331mn as receivables rose Rmb152mn YoY and inventories grew Rmb29mn YoY. Dividend payout still high. The firm declared a dividend of Rmb0.8/sh, implying a payout ratio of 82% and the current stock price implies a dividend yield of 6%.

1Q24: Revenue fell slightly, but GM rose. Revenue fell 7% YoY due to late project commencement in 1Q24, but GM rose 0.4ppt YoY to 29%. Expenses fell, and net margin grew. In 1Q24, the firm reduced selling and G&A expenses (-2% and -8% YoY), but its expense ratio rose 0.4ppt YoY due to falling revenue and weakened scale dilution. However, net margin rose 0.3ppt YoY to 11.8% due to higher other income. Cash flow improved. In 1Q24, the cash-to-revenue ratio rose 13.8ppt YoY to 119%, driving operating cash flow up Rmb137mn YoY to Rmb77.76mn. The debt-to-asset ratio fell 3.3ppt QoQ to 23.5%.

Trends to watch

Technology supports the shift toward high-end products; awaiting a smooth transition of organizational structure. In 2024, we believe major shareholders are accelerating the transfer of high-end product technologies to the company, which may enable the company to accelerate its exploration of non-ferrous metals, metallurgy, and alternative-fuel vehicle markets. Meanwhile, if the firm can cope with changes in the management team and accelerate its transformation in governance, we expect it to see technology upgrades and management optimization.

Financials and valuation

As demand is under pressure, we cut our 2024 and 2025 net profit forecasts 15% and 11% to Rmb531mn and Rmb638mn. The stock is trading at 12.7x 2024e and 10.6x 2025e P/E. We maintain an OUTPERFORM rating, but cut our target price 16% to Rmb16, implying 15.2x 2024e and 12.7x 2025e P/E and offering 20% upside.

Risks

Changes in governance structure; disappointing demand for ceramic fiber and/or integration of new businesses.