Key points of investment:

The company is a leader in the domestic circuit breaker materials and parts industry, and its performance has maintained steady development. Xinhongtai is a leading enterprise with supporting manufacturing capabilities for key components in the domestic circuit breaker industry. It was listed in July 2016. The company's main business is R&D, production and sales of key components of circuit breakers, low voltage circuit breakers and knife melting switches.

The company has outstanding R&D and design capabilities and maintains good business relationships with many well-known international and domestic electrical companies. Benefiting from the steady growth of the domestic and foreign power industry, the company's performance has maintained steady growth in recent years. In 2016, the company achieved revenue of about 377 million and net profit of 66 million yuan, up -4.39% and 0.1% respectively; in the first half of 2017, it achieved revenue of about 186 million yuan, an increase of 2.49% over the previous year, and achieved net profit of 29 million yuan, a decrease of 13.39% over the previous year.

Tianyi Shangjia, the only leader that plans to acquire domestic high-speed rail brake pads, will enter the broad market for industrial consumer goods. The company announced on August 2, 2017, that it intends to acquire 100% of the shares of Tianyi Shangjia, a leader in the domestic rail traffic gate industry. The transaction consideration is 4.32 billion yuan, of which 250 million yuan will be paid in cash, 4.07 billion yuan will be paid by issuing shares, and the issue price is 29 yuan/share. The target promised net profit for 17-19 to be no less than RMB 228.147 million, RMB 262,814,500, and RMB 303.410.7 million respectively. Based on the net profit promised in 17 years, the PE valuation of the subject matter of this acquisition was about 18.9 times. At the same time, the company plans to raise 785 million dollars in supporting capital to pay cash considerations, intermediary expenses, research and development of basic braking materials for high-speed trains, and demonstration production line projects for intelligent manufacturing.

Brake pads are one of the most commonly used consumables in rail transit equipment. Brake pads require frequent replacement in high-speed rail operations (2-4 times a year), demand is very stable, and as vehicle ownership increases rigidly, we think they are typical “industrial consumer goods”. We estimate that high-speed rail bicycles cost an average of 1-1.5 million yuan of brake pads per year. The current domestic high-speed rail market capacity is 3-4 billion yuan (based on the number of trains owned by 3,000 trains). Adding subway and locomotive gates, the total market capacity is greater than 5 billion yuan. If the total number of trains sold at home and abroad remains at the level of 400 trains each year, the number of rail transit vehicles owned will nearly double in the next 5-6 years, and the brake pad market capacity will rise rigidly to 80 to 10 billion yuan. Furthermore, with the acceleration of high-speed rail across the country, our judgment on brake pad consumption and long-term market space may be more optimistic;

Tianyi Shang Jia: A well-deserved leader in domestic high-speed rail gates, achieving national pride in import substitution. Tianyi Shangjia is a leading domestic supplier of powder metallurgy gates for EMUs and brakes for locomotives and urban rail vehicles. The brake is the core key component of the braking system, but powder metallurgy brakes for China's EMUs have long relied on imports. The target company has independent research and development capabilities and leading technology. It obtained the China Railway CRCC EMU powder metallurgy gate certification certificate in 2013, and began providing gates to Changke, and began implementing import substitution. However, with product technology development and customer expansion, the company has now provided powder metallurgy gates for EMUs to 18 railway administrations under China Railway Corporation, including 15 railway stations including Beijing, Shanghai, and Harbin. We estimate that the company's market share has reached about 20%. High-speed rail brake pads have extremely high technical requirements. Tianyi Shangjia is the only domestic supplier, and the only supplier for the Fuxing Standard.

The pace of development of high-speed rail has not abated, and the increase in the localization rate has brought new opportunities to high-speed rail exports. China's high-speed rail has developed rapidly in recent years, with an operating mileage of 22,000 kilometers in 2016. According to the NDRC's “Medium- and Long-Term Railway Network Plan”, China's high-speed rail mileage will reach 30,000 kilometers in 2020 and 38,000 kilometers in 2025, and will continue to develop steadily. With the gradual implementation of the Belt and Road Initiative, opportunities for high-speed rail to go out will continue to increase; the official launch of the Fuxing also indicates that the increase in the localization rate is a major trend. Tianyi Shangjia has strong technology and customer technology, and is the only supplier of Fuxing gates. We estimate that its market share of high-speed rail train gates is around 20%. Compared with the supply pattern of other domestic parts, there is a lot of room for improvement in the future.

Profit forecast: Industrial consumer goods are scarce, and leading localization companies enjoy a broad growth margin to enjoy valuation premiums. We estimate that Xinhongtai's net profit for 17-19 will be 5859, 641, and 69.31 million yuan respectively. Without considering additional issuance, EPS will be 0.40, 0.43, and 0.47 yuan/share, respectively. After considering mergers and acquisitions, we assume that the full-year consolidation reflects an increase in the scale of performance, and is calculated based only on Tianyi Shangjia's promised net profit of RMB 228.1470 million, RMB 262,81445 million, and RMB 303,410,700. After considering mergers and acquisitions, after considering mergers and acquisitions, the EPS of Xinhongtai headquarters in 17-19 was 0.20, 0.22, 0.24 yuan/share, and Tianyi Shangjiabu's EPS for 17-19 was 0.79, 0.91, 1.05 yuan/share. According to the valuation level of comparable companies, the average valuation of Xinhongtai's comparable electrical appliance industry companies is about 23 times. Considering that the company has not been listed for a long time, is small, and has a lot of room for future development, we have given a certain valuation premium and given PE a valuation of 40 times in '17. The average valuation of comparable companies in the rail transit industry is about 35 times. We expect the rail transit industry chain to gradually pick up, and valuations are expected to rise. Also, considering that the industrial consumer goods market where Tianyi Shangjia is located has strong scarce value. At the same time, the company is the “unicorn” of the industry and has broad room for growth, we have given PE a target valuation of 47.5 times for 2018. Taken together, the company was given a target price of 45.5 yuan to increase its holdings and ratings.

Risk warning: The development of high-speed rail fell short of expectations, and the development of the company's products and performance fell short of expectations.