Incident: The company released its 2023 annual report on August 18. 1H23 achieved revenue of 1,578 billion yuan, YoY -19.5%; net profit of 254 million yuan, YoY -48.9%; after deducting non-net profit of 244 million yuan, YoY -49.7%. The performance was in line with previous market expectations. Our comprehensive review is as follows:

2Q23 Revenue increased 46% month-on-month; the increase in the expense ratio affected the net interest rate. 1) Looking at a single quarter: 2Q23 achieved revenue of 936 million yuan, a year-on-year decrease of 16.2%, and a year-on-year increase of 46.0%; net profit returned to 127 million yuan, a year-on-year decrease of 57.9%, an increase of 0.7%; net profit of 121 million yuan, a year-on-year decrease of 59.1%; a year-on-year decrease of 1.3%. Revenue improved in 2Q23 as downstream demand recovered. 2) Profitability: 2Q23 gross margin fell 7.3 ppt to 37.9% year on year; net profit margin fell 13.7 ppt to 14.2% year on year. 1H23 gross margin fell 3.9 ppt to 39.4% year on year; net profit margin fell 9.4 ppt to 16.5% year on year. The decline in gross margin of self-produced components in the core business affected the overall gross profit margin; the increase in the cost ratio during the period affected the level of net interest rate.

The new materials sector grew 182%; active power devices were deployed through Xiamen Xinyai. By product, 1H23:1) Self-produced components: revenue of 660 million yuan, YoY -22.8%. Component sales volume and gross margin both declined year-on-year due to downstream demand recovery pressure and increased market competition. On 1H23, Shanghai Torch Group used 174 million yuan of its own capital to obtain 51.0094% of the shares of the Xiamen Xinyi Generation through share acquisitions and capital increases, and merged them to achieve a leap from passive components to active power devices, enrich the industrial layout, advance inventory business and emerging businesses, and consolidate and enhance scale and core competitiveness. 2) New materials: Achieved revenue of 70 million yuan, YoY +182.2%, accounting for 5% of total revenue. The company's new materials division completed the construction of a liquid PCS production line and established a stable order source for solid polycarbonate silane products. 3) Trade: Achieved revenue of 8.4 billion yuan, YoY -20.9%, accounting for 53% of total revenue. Trade business is affected by supply, demand, and economic conditions. Consumer customers still mainly digest inventory, and shipments have decreased year-on-year.

Contract liabilities increased 180%; operating cash flow improved markedly. The cost rate for the 1H23 period increased by 5.5 ppt to 16.6% year on year: 1) The sales expense rate increased by 1.8 ppt to 4.7% year on year; 2) the management expense rate increased by 2.4 ppt to 7.3% year on year; 3) The financial expense rate was 0.90%, 1H22 was 0.89%; 4) The R&D expense rate increased by 1.3 ppt to 3.7% year on year. As of the end of 2Q23, the company: 1) accounts receivable and notes amounted to $2.122 billion, up 8.0% from the end of 1Q23; 2) advance payments of $25 million, up 34.0% from the end of 1Q23; 3) inventory of $1,318 million, up 0.8% from the end of 1Q23; 4) contract liabilities of $0.08 billion, up 179.8% from the end of 1Q23. Net cash flow from 1H23 operating activities was $570 million, and 1H22 was $5.2 billion.

Investment suggestions: The company is a leading specialty MLCC enterprise; ceramic-based composites have large-scale production capacity and are expected to open up new space for growth; international trade expands the Southeast Asian market and gradually creates benefits. Taking into account the pace of downstream demand release, we slightly adjusted the profit forecast. We expect the company's net profit from 2023 to 2025 to be 800 million yuan, 1.04 billion yuan, and 1.28 billion yuan respectively. The current stock price corresponding to the PE from 2023 to 2025 is 19x/15x/12x. Considering the company's position in the industry and the growth potential of the new business, we gave 23 times PE in 2023, 1.80 yuan/share for EPS in 2023, and the corresponding target price of 41.40 yuan. Maintain the “Recommended” rating.

Risk warning: Downstream demand falls short of expectations, new product development falls short of expectations, etc.