Incident: The company released its 2019 annual report on April 28. During the reporting period, the company achieved operating income of 2,206 million yuan (+56.23%); Guimu's net profit was 280 million yuan (83.46%). At the same time, the 2020 quarterly report was released, showing revenue of 439 million yuan (+52.79%) and net profit of the mother was 101 million yuan (-23.32%) during the reporting period.

Key points of investment

The company's performance grew steadily in 2019. In 2019, the company achieved operating income of 2,206 million yuan (+56.23%); net profit of 280 million yuan (83.46%); total non-recurring profit and loss of 133 million yuan, net profit after deduction was 146 million yuan, mainly due to income tax deductions for loss of debt losses of subsidiary Chengdu Xinhuaxin and income tax accrued and deducted by Chengdu Yaguang Electronics. Among them, Chengdu Yaguang earned 1,723 million yuan (+59.00%), and the net profit of its mother was 428 million yuan (+83.00%). During the reporting period, the company focused on improving management quality, increasing market share, and increasing investment in new product research and development. R&D expenses reached 65 million yuan, an increase of 73.74% over the same period last year, and achieved encouraging results in technological innovation of projects and new products and processes. By business, the military electronics business achieved revenue of 1,086 million yuan (+42.74%), accounting for 49.23% of total revenue; the shipbuilding business achieved revenue of 446 million yuan (+6.26%), accounting for 20.23% of total revenue. In terms of gross margin, the overall gross profit margin was 24.71% (-9.46pcts), the gross profit margin of the military electronics industry was 40.75% (-5.45pcts), and the gross profit margin of the shipbuilding business was 14.25% (-10.90pcts); during the reporting period, the operating costs of both businesses increased year-on-year, resulting in a relative decline in profitability. In the first quarter of 2020, the company achieved revenue of 439 million yuan (+52.79%) and net profit of 31 million yuan (-23.32%). The main reason for the change in performance was due to the impact of the novel coronavirus pandemic. There was a certain delay in the delivery and revenue confirmation of the company's first-quarter orders. Coupled with the seasonal impact of the military goods business, the company's first-quarter performance declined to a certain extent compared to last year. Among them, the net profit of the subsidiary Chengdu Yaguang increased 4.39% year on year, while the boating business was greatly affected by the COVID-19 pandemic. Order delivery was delayed a lot, and the first-quarter performance declined somewhat compared to last year.

The military electronics business continues to step up technical reform and marketing efforts. As one of the main designated manufacturers of military microwave integrated circuits in China, the company's military electronics business achieved revenue of 1,086 million yuan (+42.74%) and operating profit of 443 million yuan (+25.85%) in 2019. The company issued shares at 1,295 yuan/share in 2017 and purchased 97.38% of Chengdu Yaguang's shares at a price of 3,342 million yuan. The promised profit for 2017-2019 was 160, 220, and 3.1 billion yuan respectively. It has fulfilled its performance promise for all three years, exceeding 118 million yuan in 2019. As the main production unit, Chengdu Yaguang's main products are semiconductor discrete devices, chips, microwave circuits and components (collectively “military products”). During the reporting period, the company accurately grasped the two major trends of miniaturization and localization of military electronics development and actively carried out strategic research on new products. Military products have steadily improved in terms of quality and technology. During the reporting period, the company completed the “two licenses in one” rectification and inspection of the military system and obtained a certificate; 4 new vertical scientific research projects were added throughout the year, high-density integrated packaging microwave module technology projects were added, and strived to achieve breakthroughs in product miniaturization, integration and microsystematization; through R&D, production line cooperation and the construction of mature customer management systems, the company continued to strengthen “targeted” supply relationships with core customers, and continued to expand the 5G/6G joint base station joint laboratory built with the Second Academy of Aerospace Science and Industry R&D and other series of dual-use military and civilian services ; Further increased the OEM production capacity of the Five Aerospace Science and Technology Institutes; introduced intelligent manufacturing management systems from CLP 14 institutes, improved customer informatization service systems, etc. At the same time, the company continued to expand its marketing efforts and increase its market share. Among them, microwave single-chip integrated circuit sales promotion achieved certain results. The number of export users increased from only 7 last year to more than 100, and the number of models sold increased from 36 last year to close to 200.

The boating business may usher in restorative development. During the reporting period, the company invested 121 million yuan in R&D, an increase of 85.00% over last year, mainly for the design and development of new ship models, composite material process improvement and material testing, modular design and standardized design of new ships. During the reporting period, the company followed the intelligent development trend of the shipping market. Marine electronics technology, dominated by radar products, was the core technology of high-tech ships, especially unmanned ships and smart ships. The application and development of marine electronics will be the key to enhancing the competitiveness of the company's marine products. Combining the company's technological advantages, using Chengdu Yaguang's technical resources to upgrade and supplement marine power technology, enhance intelligent ship manufacturing capacity through an intelligent pilot control boat platform, expand the smart ship business based on existing unmanned boat and special boat technology, and further increase the market share of marine products. In May 2019, the company signed a large-scale naval patrol boat intent order with an overseas special company, which will enable the company's traditional boat business to stop being a drag on the company's overall performance. At the same time, the company's boat business will also truly enter the military industry field, opening up new space for the collaborative development of the company's two main businesses, military and civilian, and is expected to usher in restorative development in the future.

A breakthrough was achieved in the civilian goods business. In terms of civilian products, Chengdu Yaguang Electronics and China Sea Hawk, 35 of the China Sea Hawk Institute of Aerospace, jointly developed the “Space Sea Hawk” AI millimeter wave human security detector. The 8mm T/R components used are all manufactured by Chengdu Yaguang's Microwave Millimeter Wave Technology Research Institute. The module mainly consists of three parts: a receiving module, a transmitting module, and a frequency integrated control module. The official launch of this product marks another major breakthrough in the expansion of the company's military technology products into the civilian market.

Investment advice: As a provider of military electronics, microwave radar, and intelligent boat system solutions, the company has a sound technical system and iterative innovation capabilities. As the deployment and delivery of key weapons and equipment in China accelerates, there is a high degree of certainty that military reform will enter the middle and late stages of order recovery and compensatory growth. The company's net profit from 2020 to 2022 is estimated to be 409, 500, and 603 million yuan respectively, and EPS is 0.41, 0.50, and 0.60 yuan respectively, giving 35 times PE in 2020 corresponding to a target price of 14.35 yuan. The current stock price corresponds to 25, 21, and 17 times PE respectively.

Risk warning: product development risk; risk of fluctuations in military product orders.