Incident: Zhongke Sanhuan released its 2022 semi-annual report. During the reporting period, the company achieved operating income of 4.7 billion yuan, an increase of 68.44% over the previous year; net profit attributable to shareholders of listed companies was 405 million yuan, an increase of 251% over the previous year. The net profit of 2022Q2 attributable to shareholders of listed companies in a single quarter was 239 million yuan, up 267.42% year on year and 43.98% month on month.

Strong demand for new energy supports the rise in gross profit of NdFeB, driving high growth in the company's performance. The increase in performance mainly benefited from strong downstream demand, which led to higher prices of NdFeB products and higher company orders. The performance of new energy vehicles showed strong resilience under the influence of the epidemic. In the first half of 2022, domestic NEV sales totaled 2.6 million units, an increase of 115.7% over the previous year. Driven by demand, the market price of high-end NdFeB rose sharply during the same period. Data from Baichuan Yingfu showed that in the first half of 2022, the average domestic sintered NdFeB H35 rough market price was 339.64 yuan/kg, up 68.84% year on year and 34.57% month on month. According to the company's disclosure, it usually takes 3-6 months to transfer costs due to changes in raw material prices. According to the three-month cost conduction cycle for observing raw material prices, February 2022 was the highest point in the current round of rare earth market since April 2020. Although rare earth prices declined for a short time in mid-April, overall, rare earth prices in the first half of this year were still relatively high in history. Among them, the average price of rare earths in the first quarter was the highest average price in this round of the current market. The average price of praseodymium oxide in Q1 reached 1,055,500 yuan/ton, up 99% year on year and 30% month on month. The products sold by the company to foreign countries are mainly high-end NdFeB products. Due to the advanced processing technology and high-end product performance, the prices of the company's products have enjoyed the dividends in this round of price increases. The company's 202H1 gross margin increased 2.68 percentage points year-on-year to 18.02%, of which 202Q2 single-quarter gross margin rose to 18.49%. In addition, exchange gains and losses also contributed to the company's performance. The company's export revenue accounted for about 50% of revenue, mainly settled in US dollars. The cumulative decline of RMB against the US dollar in the first half of 2022 was nearly 5%. Exchange gains and losses brought about by the devaluation of the RMB and changes in international prices of the company's export products also contributed to the company's performance.

An additional 10,000 tons of production capacity was put into operation over the course of the year, creating an impetus for continued performance. The company currently has a total NdFeB rough production capacity of 21,500 tons/year. The production capacity of 10,000 tons of sintered NdFeB blanks, which is being expanded, is expected to be completed and put into operation in the second half of this year. At that time, the total production capacity will reach 33,500 tons.

In terms of long-term planning, the company is expected to expand sintered NdFeB production capacity to 51,000 tons by the end of 2024, which will continue to drive future performance.

The advantage of being in the new energy sector provides a first-mover advantage for new business development. Among the company's downstream product distribution, new energy vehicles account for 29%, traditional vehicles account for 26%, consumer electronics 20%, computer fields account for 5%-10%, energy-saving motors account for about 5%, industrial motors account for about 5%, and other application fields account for 5%-10%. The company was one of the first domestic magnetic material companies to start supplying NdFeB products to overseas NEV manufacturers. Since the certification cycle for overseas NEV manufacturers is generally 2 years or more, the certification cycle is long. As the first NdFeB company to enter the overseas NEV supply chain, the company has accumulated a long-term high-quality customer base based on strong technical advantages and stable supply capacity. It is the main supplier of Tesla, the world's leading NEV, providing a first-mover advantage for emerging fields of humanoid robots in the future.

Lay out the supply side of raw materials to improve cost control capabilities. The cost of NdFeB is highly correlated with the prices of rare earth raw materials neodymium, dysprosium, and plutonium. The company continues to allocate upstream resources through measures such as participating in Southern Jiangxi Rare Earth High Technology and Ganzhou Keli Rare Earth New Materials, signing strategic agreements with Minmetals Nonferrous Metals, and setting up a Ganzhou joint venture with Southern Rare Earth to guarantee the supply of raw materials and mitigate the impact of price fluctuations on costs.

Investment advice: With steady growth gradually gaining momentum, demand in fields such as wind power and industrial motors is expected to accelerate, while the boom in new energy vehicles continues to rise, humanoid robots are more likely to bring new demand growth points for rare earth permanent magnets. Although there is still room for a slight decline in the current price of rare earths, medium- to long-term rare earth prices are expected to gradually stabilize and slowly rise, supported by fundamentals. As a leading rare earth permanent magnet company, Zhongke Sanhuan is expected to continue to benefit from the high growth in downstream demand, and the steady expansion of production capacity is conducive to the continued release of performance elasticity. The company's net profit attributable to shareholders of listed companies in 2022-2023 is estimated to be 896,1,234 million yuan, corresponding to 2022-2023 EPS of 0.74 and 1.02 yuan, and corresponding PE for 2022-2023 to be 23x and 19x, maintaining the “recommended” rating.

Risk warning: 1) downstream demand fell short of expectations; 2) rare earth prices fell sharply; 3) the company's production expansion fell short of expectations