3Q22 results in line with our forecast

Lets Holding Group announced its 1-3Q22 results: Revenue declined 14.2% YoY to Rmb3.06bn and net profit attributable to shareholders fell 9.9% YoY to Rmb209mn. In 3Q22, revenue dropped 18.2% YoY to Rmb1.05bn and attributable net profit declined 9.8% YoY to Rmb73.79mn. Its 3Q22 results were in line with our expectations.

GM rose YoY and QoQ due to lower costs and YoY increases in product prices. In 3Q22, the firm's overall gross margin （GM） increased 3.2ppt YoY and 0.5ppt QoQ thanks to YoY increases in product prices （the company raised product prices in 4Q21） and YoY and QoQ declines in costs. The ex-factory price of HPEG at Liaoning Aoke dropped 7% YoY and 9% QoQ in 3Q22.

Revenue declined; expense ratios rose YoY and QoQ. The production volume of cement in China fell 12.5% YoY in 1-3Q22 to 1.56bnt due to weakening demand in the real estate industry and delay in the execution of infrastructure construction projects. In 3Q22, the production volume of cement in China fell 6% YoY to around 589mnt. The YoY decline in cement production volume narrowed in 3Q22. We estimate that sales volume of additives fell 6-10% YoY in 3Q22. This, coupled with declines in revenue from other projects, led to an 18.2% YoY decline in the firm's revenue in 3Q22. Its selling, G&A, and financing expense ratios came in at 4.7% （+0.6ppt YoY）， 3.6% （+0.4ppt YoY）， and 0.4% （+0.3ppt YoY） in 3Q22, due to lower revenue. In 3Q22, its combined selling, G&A, and financing expense ratio rose 1.3ppt YoY to 8.7%.

Credit impairment losses ahead. In 3Q22, the company made around Rmb11.84mn in provisioning for credit impairment losses. We foresee credit impairment losses ahead given weak demand in downstream industries and relatively tight capital along the value chain.

Cash flow remained sound. The firm's operating net cash flow rose 32% YoY to around Rmb162mn in 1-3Q22 thanks to effective payment collection.

Trends to watch

We expect mild recovery in demand; market share to increase in the medium term. Data from the National Bureau of Statistics （NBS） shows that in September, the production volume of cement in China rose 1% YoY to around 210mnt, recording a positive growth rate for the first time since May 2021. Demand shown a mild recovery since September, as evidenced by high-frequency data in downstream industries. We think sales volume will increase in 4Q22 given demand recovery amid accelerated infrastructure construction. In the medium term, we think small companies are likely to exit the market due to weak demand, the tightening of environmental regulations, and volatile costs. The company may continue to gain market share by leveraging its leading position in the domestic additive industry.

Financials and valuation

We cut our attributable net profit forecasts by 16.5% to Rmb272mn for 2022 and 18.0% to Rmb338mn for 2023 to reflect changes in our assumptions on sales volume, earnings per tonne, and expense ratios. The stock is trading at 14.7x 2022e and 11.9x 2023e P/E. We maintain an OUTPERFORM rating, but cut our target price 7% to Rmb6.98 to reflect lower earnings forecast and slower recovery of the industry. Our TP implies 18.4x 2022e and 14.8x 2023e P/E, offering 25% upside.

Risks

Credit impairment losses exceed our expectations; demand recovery disappoints.