Performance review
Taiji Industries reported 3Q revenue of 4.1 billion yuan in 2019, a 10% month-on-month decline but accelerated to 16% year-on-year growth (1Q19's 7% y, 2Q19's 10% y), and operating margins fell to 4.3% in the third quarter from 6.0-6.5% in the second quarter of this year and the same period last year. Third-quarter diluted earnings per share reached CNY$0.08, a month-on-month decline of 13 per cent, up 2 per cent from a year earlier, and diluted earnings per share reached CNY$0.22 in the first three quarters, accounting for 74 per cent of our full-year forecast for diluted earnings per share.
Business analysis
Quarterly revenue rollback, but year-on-year acceleration: we attribute Taiji Industrial's revenue in the third quarter to a 10% quarter-on-quarter rollback due to the lack of confirmed design revenue and storage customer inventory, but it is still up 16% year-on-year compared with the same period last year, higher than 7% year-on-year revenue growth in the first quarter and 10% in the second quarter. We currently estimate that Taiji can easily grow by 15-20% month-on-quarter in the fourth quarter, and the revenue for the whole year can exceed the target.
The short-term profit rate is not as expected: although Taiji's annual revenue exceeds the target, demand is affected by the memory downward cycle, the price pressure of some products, and the clean room general contracting project in which the product portfolio tends to have a low gross profit margin. As a result, its gross profit margin and operating profit margin have fallen.
Growth momentum is expected in the next five years: although we are still conservative about the prosperity of the DRAM/3D NAND memory industry, a large number of 5G mobile phones (2-250 million units) and server demand recovery (5years revenue CAGR > 10%) worldwide next year are expected to lead the memory industry out of the trough and facilitate the recovery of Taiji's memory closed testing business. The upcoming mass production of Changjiang Storage, coupled with the production expansion plans of Hefei Changxin and Ziguang Chongqing / Storage in the next five years, are beneficial to the memory closure test of Taiji and the clean room design and general contract project of memory manufacturing.
Investment suggestion
We believe that as far as A shares are concerned, 10-15 per cent ROE should be kept at 3.0 per cent of net worth per share. Based on our target price CNY$11.7 (there is still 63% room to rise), the stock price is 3.2 times the net worth per share in 2021, and we estimate that ROE will rise from 8.9% in 2018 to 12% in 2021.
Risk hint
Customers focus on the high operating risk, the risk of memory downcycle to cash cost price, the risk of inflexible management mechanism of state-owned enterprises, and the performance risk caused by the lack of follow-up orders in clean room engineering and design business.