Incident: China Rare Earth released its 2022 annual report and the report for the first quarter of 2023. The company achieved revenue of 3.786 billion yuan in 2022, an increase of 27.33% over the previous year; achieved net profit attributable to shareholders of listed companies of 416 million yuan, an increase of 112.70% over the previous year; and achieved net profit of 410 million yuan after deducting non-net profit of 410 million yuan, an increase of 116.65% over the previous year. 2023Q1 achieved revenue of 1,481 million yuan, an increase of 22.60% over the previous year, an increase of 139.92% over the previous year; achieved net profit of 19 million yuan, a year-on-year decrease of 88.42%, a decrease of 59.08% from the previous year; and achieved net profit of 19 million yuan, a decrease of 88.62% from the previous year and a decrease of 59.63% from the previous month

The company's performance in 2022 was impressive. 1) Volume: In 2022, the company achieved output of 3,664 tons, an increase of 75.44% over the previous year. The main reason was the company's integrated arrangements for its own business operations and market environment; sales volume was 3,979 tons, a decrease of 52.51% over the previous year, mainly affected by the sales structure. 2) Price: The average price of the company's rare earth oxides sold in 2022 was about 950,000 yuan/ton, up 600,000 yuan/ton over the previous year (+168%). 3) Profit: Due to the upward trend in rare earth prices in '22, the company's gross margin in 2022 was 17.06%, +4.38 pcts year on year. From the perspective of profit per ton per ton, the company's net profit per ton of rare earth products rose from about 23,000 yuan/ton in 2021 to 105,000 yuan/ton in 2022, an increase of more than three times over the previous year.

The decline in rare earth prices caused the company to prepare for a drop in inventory prices, and the first-quarter results were under pressure. In the first quarter of 2023, rare earth prices declined rapidly. Praseodymium oxide fell from 717,500 yuan/ton at the beginning of the year to 522,500 yuan/ton, a drop of up to 27%; dysmium oxide dropped 17% to 2.07 million yuan/ton; and lithium oxide fell 27% to 10.3 million yuan/ton. At the end of 2022, the company had 2,329 tons of rare earth inventories, an increase of 58.14% over the previous year. Higher rare earth inventories combined with a sharp drop in rare earth prices caused the company's asset impairment loss of 128 million dollars, which directly affected the company's profit in the first quarter. Also, due to the rapid decline in rare earth prices, the company's gross margin fell to 11.24%, -11.03 pcts year on year and +1.86 pcts month on month. Looking back, with the gradual recovery of downstream demand, rare earth prices are expected to bottom out and support the company's performance upward.

Improved ability to control fees. The cost rate for the company period in 2022 was 2.06%, a year-on-year decrease of 1.49 pcts, of which the management/sales/finance/R&D expenses ratio was 1.06%/0.08%/0.47%/0.45%, respectively; the 2023Q1 corporate period expense ratio was 0.89%, a decrease of 2.38 pcts over the previous year, and an increase of 1.08 pcts over the previous month, of which the management fee rate was 0.61%, the year-on-year -1.44pcts; the financial expense ratio was 0.01%, the year-on-year decrease of -0.88pcts, mainly due to reduced interest expenses due to reduced interest expenses on bank loans As a result; the R&D expenses rate was 0.25%, a year-on-year decrease of 0.05 pcts; the sales expense ratio was 0.04%, a year-on-year decrease of 0.01 pcts.

As the acquisition of Jianghua rare earths continues to advance, the company's profit level is expected to reach another level. Currently, the company's assets are mainly concentrated in the rare earth smelting and separation process. Currently, there are two separation plants, Dingnan Dahua and Guangzhou Jianfeng, with a total separation capacity of 7,400 tons. The company's acquisition of Jianghua rare earths will further improve the layout of the rare earth industry chain. The Guposhan Mining Area of Jianghua Yao Autonomous County holds 37,890 tons of rare earth oxide reserves (REO) within the scope of the mining license, with a design capacity of 2000 tons of REO/year. After the acquisition is completed, the company's self-sufficiency rate of rare earth resources will reach about 16%. As the self-sufficiency rate of rare earth resources increases, the company's profitability will increase dramatically.

The price of rare earths is expected to bottom out in the short term, and there is no need to worry about the medium to long term prosperity. Rare earths have been continuously adjusted since the third quarter of last year. As demand gradually recovers, prices are expected to gradually bottom out and rebound. Looking at the extended cycle, in the context of high carbon neutrality, demand has exploded in fields such as new energy vehicles, industrial energy-saving motors, and humanoid robots, and the prosperity of the industry is worry-free. However, on the supply side, domestic rare earth supply is controlled by indicators. Overseas mines such as Mt Pass, Lynas, and Myanmar do not have large capital expenditure plans, rare earth supply is inflexible, and the rare earth price center is expected to rise in the medium to long term.

Profit forecast and investment advice: Assuming that the price of praseodymium oxide in 23/24/25 was 50/55/600,000 yuan/ton, respectively, the price of prosidium oxide was 200/220/2.4 million yuan/2.4 million yuan/ton, respectively, and the price of zinc oxide was 1000/1200/14 million yuan/ton respectively. The estimated net profit of the company to the mother was 291/452/513 million yuan respectively (the earnings forecast for 23-24 of January 4, 2023 report was 485 million yuan and 531 million yuan respectively). The current stock price corresponds to 23/24/25 PE valuation of 107.8/69.3x/61.0x. Maintain the company's “increase holdings” rating.

Risk warning: Fluctuations in raw material costs, production capacity release falling short of expectations, industry sentiment falling short of expectations, risk of deviations in demand estimation, risk of public data used in research reports not being updated in a timely manner, risks of profit forecasts falling short of expectations due to changes in core assumptions, etc.