Incident: The company released its 2022 financial report. Revenue in '22 increased 1.49% to 2,208 billion yuan, and the net profit of the mother decreased by 30.01% to 163 million yuan. Gross margins and net margins were 11.79%/7.38% respectively, with year-on-year changes of -6.75/-3.32pct respectively. The decline in gross margin is mainly due to the decline in domestic cotton prices and weak downstream demand, and the pressure on the profit side is obvious. Looking at Q4 alone, revenue fell 11.13% to 590 million yuan, net profit of the mother decreased by 67.40% to $23 million, and gross margins were 7.59%/3.89% respectively, with year-on-year changes of -9.96/-6.71 pct, respectively.

The slight increase in revenue showed some resilience, and the profit side was affected by fluctuations in cotton prices and was under pressure in the short term. (1) Revenue side: Revenue increased 1.49% to 2.208 billion yuan in '22, of which revenue from colored yarns/trade yarns/processing fees was 19.72/164/061 million, respectively, up 1.0%/0.7%/19.4%, respectively; (2) profit side: The year-on-year decline in gross margin in 2022 was 6.75pct to 11.79%, mainly due to the downward impact of cotton prices. Among them, 22Q4 gross margin fell 9.96 pct to 7.59%. Among them, the gross margin for colored yarn/trade yarn/processing fees was 12.0%/4.1%/17.6%, respectively, with year-on-year changes of -6.7/-3.5/-17.4 pct, respectively. The sales/management/finance/R&D expenses ratio in 2022 was 0.53%/1.96%/3.23%/-0.46%, respectively. The year-on-year changes were +0.03/-0.19/+0.01/-0.16pct, respectively, and the net profit margin decreased by 3.32 pcts to 7.38% year on year.

Warehouse-based production and full tank production have outstanding cost advantages and strong environmental control capabilities. The company uses a production model of “mainly warehousing-based production, supplemented by order-based production”, which ensures that purchases are made at any time and can be purchased at any time. Under full tank production, the company has a cost advantage and is deeply tied to downstream customers. Currently, the company's warehoused production model accounts for more than 95% of sales, the company's capacity utilization rate remains above 100%, and the production to sales ratio is over 97%. Furthermore, the company has a unique advantage in terms of energy costs. The water used is mainly Yangtze River water, steam is supplied by self-built boilers, and electricity is passed through the national grid. In terms of environmental protection, it has a complete wastewater and exhaust gas treatment system, as well as a number of energy saving and emission reduction technologies.

Focus on the release of production capacity brought about inflection points in performance, and the expansion of new categories of customers opens up room for growth. Existing production capacity is saturated, and additional production capacity was gradually released in 23 years, laying a solid foundation for the company's growth. In 2018-2020, the company's capacity utilization rate was over 100%, and the production and sales rate was around 100%.

By the end of 2021, the company's current production capacity was 720 million tons, including 66,000 tons of high-end colored yarn and 6,000 tons of mercerized cotton per year. Production capacity under construction includes a fiber dyeing project with an annual output of 30,000 tons in Wuhu and a production base project of 60,000 tons in Jingzhou. Among them, the Wuhu project with an annual output of 30,000 tons is expected to be completed by the end of 2022, the first workshop of the 60,000-ton project in Jingzhou is expected to be put into operation in March 2023, and the second workshop is expected to be put into operation by the end of June 2023. With the gradual expansion and climbing of production capacity, the company's yarn business is expected to expand further, laying a solid production capacity foundation for the company's growth. The company is actively expanding downstream customers, from socks to clothing, towels and other categories, opening up room for the company to grow.

Profit forecasts and investment suggestions: Affected by the pace of production capacity commissioning and fluctuations in raw materials, the company was at the bottom of the double bottom of production capacity and profitability in '22. Production capacity growth officially entered the fast track in '23, and the profitability center improved. The company is the target of a clear inflection point in fundamentals, and production capacity and orders will continue to be catalytically implemented throughout the year. Stricter environmental regulations have made the industry have a certain entry threshold, and speeding up the clean-up of small and medium-sized enterprises is beneficial to optimizing the industry pattern. The company has been deeply involved in the colored yarn industry for 20 years and has scale advantages under its unique warehousing production model. Furthermore, it has strong cost control capabilities and outstanding energy cost advantages, and is expected to further increase market share through cost advantages and scale advantages. Future growth: (1) The release of production capacity drives growth, and it is expected that the release of production capacity in 2023 will bring growth on the revenue side; (2) Downstream category customer expansion: The company occupies a leading position in the sock category. Socks are everyday consumer goods, have certain mandatory attributes, are less affected by macro and other factors, and the company will benefit from steady growth in the industry; in addition, downstream continues to expand into fields such as towels, sweaters and home textiles. We expect the company's net profit for 2023-2025 to be 272/3.39/453 million yuan, the corresponding EPS is 2.18/2.72/3.63 yuan. The current stock price corresponding to PE is 9.52/7.64/5.72 times, respectively, giving it a “buy” rating.

Risk warning: raw material prices fluctuate greatly, capacity expansion falls short of expectations, downstream demand falls short of expectations, etc.