Rating:BUY (Initiation)
Share price (22 Sep): RMB30.85
Market Cap (RMBm): 3,702.0
We Initiate coverage with a BUY call. Zhongzhou has a broad downstream market and is set to expand on incremental capacity releases. It has an entrenched position in high-temperature corrosion-resistant alloys at the high end of the civilian market. Its downstream markets, including nuclear power, environmental protection and automotive, enjoy high inventory demand and policy support, boosting its future growth stability.
Incremental capacity releases set to drive future growth
Zhongzhou’s downstream market is broad and set to expand with future incremental capacity releases. It has an entrenched position in high-temperature corrosion-resistant alloys at the high end of the civilian market. Its downstream markets include petrochemical, nuclear power, automotive and environmental protection. Nuclear power, automotive and other applications enjoy high inventory demand and support the company's profitability. Policy support is driving its downstream markets such as nuclear power and environmental protection, boosting stability for the company's current and future growth.
China and overseas sales networks: high-quality and stable customer base
Zhongzhou supplies to large domestic and foreign companies such as GE, Emerson, Schlumberger, Velan, L&T, Flowserve and Neway. Its stable customer relationships augur well for future incremental profitability. Its products, high-temperature corrosion-resistant alloys and special alloy, are approaching full production with high sales levels. Revenue/net profit had CAGRs of 13%/16% over 2018-20. The company's high-temperature corrosion-resistant alloy casting and special alloy welding consumable businesses maintain high gross profit margins of around 25%. Since 2016, annual high-temperature corrosion-resistant alloy revenues have exceeded 70%. We see high profit growth prospects in view of its planned production capacity releases.
Capital investment aids gradual capacity expansion and profitability is set to rise
In the domestic market for high-temperature alloys for civilian use, many of the manufacturers make mid to low-end products with annual production levels generally below 1,000 tons. As a large-scale high-end civil company, Zhongzhou’s high-temperature corrosion-resistant alloys have a capacity of 3,100 tons. A project that will commence production in 2022E is set to help the company break its capacity bottleneck. We estimate 2,550 tons of additional capacity on reaching full utilization in 2023E. Its production scale in this product is much higher than those of other companies.
Valuation and risks
We expect net profit of RMB94m/118m/127m in 2021/22/23E, with corresponding EPS at RMB0.79/0.99/1.06 and current PE at 37.3x/29.7x/27.6x. We view a 2022E PE of 40-45x as a reasonable valuation range, corresponding to a target price range of RMB39.6-44.55. We Initiate coverage with a BUY call.
Risks include: fluctuating raw material prices; resurgence of the Covid-19 pandemic; roadblocks to the launch of fundraising projects; and share price fluctuations caused by lower outstanding shares.
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