Core views:

Runhe High-Tech Materials focuses on the deep processing of silicone and has gained a foothold in modified silicone oil. With sustained technical upgrading, the Company has built a presence in high-end cosmetics silicone oil, optical & integrated circuit (IC) materials and thermal conductive interface materials, and has been gradually premiumizing its product structure. With the commissioning of Runhe's incremental capacity, we expect the capacity of high-end new materials to account for more than 50%, which, coupled with the low costs of raw materials, will likely drive up its gross profit margin (GPM). We forecast its 2022E-24E attributable net profit (ANP) to be Rmb101mn/133mn/180mn, equivalent to EPS forecasts of Rmb0.79/1.05/1.42, respectively. With the PE and DCF multiples of comparable companies as references, we assign a target price of Rmb34 on 32x 2023E PE and initiate coverage with a "BUY" rating.

Abstract:

Focusing on deep processing of silicone with improving profitability.

Runhe focuses on the deep processing of silicone, and its products cover 16 fields including thermal management, personal care, textile printing and dyeing, new energy and so on. In 2022, the Company achieved expansion in production capacity. Despite the operating revenue decline (-11% QoQ) in 3Q22 due to the weakened prosperity of textile auxiliaries, the attributable net profit (ANP) increased by 5% QoQ, implying the resilience of the Company. We are optimistic about the steady improvement of profitability brought in by capacity release planned by the Company for 2023-24.

Incremental capacity in high-end fields and optimization of product structure.

Runhe's newly-added capacity mainly includes silicone oil for high-end cosmetics, thermal conductive interface materials, demolding agents for metal die-casting, optical & IC materials, with an increase of 30kt of capacity in 2022-24, doubling the existing capacity of deep processing. The Company also targets fields with high prosperity and great potential, and covers high value-added products. With the gradual release of the capacity, the product structure will continue to be optimized. The Company has built new production capacity in Xinghuo Industrial Park (located in Jiujiang City, Jiangxi Province), and lowered the transport costs by fully leveraging the raw material resources of silicone in the industrial park. We are bullish on the further GPM improvement of the Company.

Production and sales of textile auxiliaries may pick up.

Runhe has a stable fundamental of textile auxiliary products and mainly produces high-end products such as block silicone oil. In 2021, its textile auxiliary capacity increased by 48%, and the production of self-used intermediates expanded at the same time, implying a further improved value chain. In 2022, the Company expanded the production of high-end products, such as tri-prevention finishing agent, to optimize the product structure. With the positive economic trend in China, the prosperity of the textile and apparel industry is likely to rebound. According to the China National Textile and Apparel Council, the textile industry prosperity expectations index was 53.8%(+9.5ppts QoQ) in 4Q22. The textile printing and dyeing auxiliaries of the Company are likely to achieve stable growth.

Low raw material price may drive up the GPM.

In 2022, Runhe's low viscosity silicone oil for cosmetic products gradually ramped up with improvement in profitability. The GPM of 1Q/2Q/3Q22 was 21.3%/22.8%/24.0%, respectively. In the future, with the release of high-end silicone new materials, such as silicone oil products for cosmetics, electronic products, thermal conductive interface materials, and pressure sensitive adhesive (PSA) of optical products, the gross profit of the Company's deeply-processed silicone products per ton is likely to increase. At present, there is overcapacity in the silicone intermediate industry. The price of dimethylcyclosiloxane (DMC), the Company's main purchased raw materials, is at a low level, which may expand the profit margin of the products. We expect the GPM of the Company to be 22.8%/23.8%/24.1% in 2022-24. Run he, by virtue of its high-end deep processing capability, is likely to stand out in the industry.

Potential risks: A high volatility in the macro economy; price war triggered by the expansion of the textile auxiliaries industry; lower-than-expected promotion of new silicone materials; slower-than-expected construction progress of the new capacity; fluctuated price of main raw materials; profit decline caused by depreciation and amortization of new capacity; safety production issues.

Investment recommendation: Runhe focuses on the deep processing of silicone and has gained a foothold in modified silicone oil. With sustained technical upgrading, the Company has built a presence in high-end cosmetics silicone oil, optical & integrated circuit (IC) materials and thermal conductive interface materials, and has been gradually premiumizing its product structure. With the commissioning of Runhe's incremental capacity, we expect that the capacity of high-end new materials will account for more than 50%, which, coupled with the low costs of raw materials, will likely drive up its gross profit margin (GPM). We forecast its 2022E-24E attributable net profit (ANP) to be Rmb101mn/133mn/180mn, equivalent to EPS forecasts of Rmb0.79/1.05/1.42, respectively. With the PE and DCF multiples of comparable companies as references, we assign a target price of Rmb34 on 32x 2023E PE and initiate coverage with a "BUY" rating.