Event: On October 25, 2023, Lear Chemical released its 2023 three-quarter report. The company's operating income for the first three quarters was 6.06 billion yuan, down 22.42% year on year; net profit was 560 million yuan, down 62.47% year on year; net profit after deducting non-net profit was 554 million yuan, down 62.68% year on year. The corresponding company's 3Q23 operating income was 1,537 billion yuan, down 24.16% from the previous month; net profit was 80 million yuan, down 60.84% from the previous month.

The plant protection industry cycle is declining, and the company's performance is under pressure in the short term. The year-on-year decline in the company's revenue was mainly related to the removal of inventories in the plant protection industry and the decline in prices of major pesticide products. As of 3Q23, the price of ammonium oxalate, the company's main product, is still in a downward cycle. According to Tonghuashun financial data, the price of the original drug of ammonium phosate in 3Q23 (95% physical) was 62,800 yuan/ton, down 72.80% year on year and 19.59% month on month. The company's sales expenses for the first three quarters fell 3.79% year on year, sales expenses were 1.48%, up 0.28pcts year on year; management expenses were up 18.07% year on year, management expense ratio was 5.26%, up 1.81pcts year on year; financial expenses rose 94.13% year on year, financial expenses were -0.10%, up 1.25pcts year on year; R&D expenses fell 10.29% year on year, and R&D expenses were 4.06%, up 0.55pcts year on year. The company's net profit to its parent declined in the first three quarters. The net profit margin was 11.78%, down 9.82 pcts from the previous year.

The company's net cash flow changed significantly in the first three quarters. Net cash flow from operating activities was $338 million, down 80.84% year on year; net cash flow from investment activities was -1,585 million yuan, down 7.89% year on year; and net cash flow from fund-raising activities was $934 million, up 305.23% year on year. The balance of cash and cash equivalents at the end of the period was $1,079 million, down 9.85% year on year. Accounts receivable decreased by 22.09% year over year, and the turnover ratio of accounts receivable declined, from 5.28 in the same period in 2022 to 4.17.

Inventories fell 7.81% year over year, and the inventory turnover rate declined from 3.36 times in the same period in 2022 to 2.83 times.

The pesticide industry is at a low point in the short term due to inventories, and long-term demand is improving. From a long-term perspective, the continuous growth of the world population and the continuous decline in the area of cultivated land per capita place higher demands on crop yield per mu, which in turn drives the continuous expansion of the global pesticide market. According to S&P Global CommodityInsights data, the global pesticide market grew from US$35.575 billion to US$87.7 billion in 2006-2022, with a compound annual growth rate of about 5.80%. Looking at the medium term, in 2022, due to the Russian-Ukrainian conflict, food security issues became the focus of attention of all countries, and international food prices rose. According to data from the International Monetary Fund, the global average prices of wheat and corn in 2022 were 360.17 and 318.36 US dollars/ton, respectively, which are at historic highs. The high level of food prices has stimulated farmers' willingness to grow, which in turn has boosted the demand for pesticides and other related plant protection products. Looking at the short term, pesticide demand declined sharply in the first three quarters of 2023 due to the high inventories of upstream manufacturers. The price of pesticide products fell significantly, and the pesticide industry was affected to a certain extent. We believe that global agricultural product prices are still in a good position, farmers' enthusiasm for using drugs is still high, and pesticide demand is at a good level. The sharp drop in global pesticide product prices has bottomed out, and the prices of some pesticide types are in the bottom range of history. Looking at the extended cycle, pesticide product prices are expected to gradually rise in the future.

The company's main products, ammonium phosate and refined ammonium sulphosate, have room for the future. The company's pesticide products mainly include organophosphorus and chloropyridine herbicides. The main product of organophosphorus herbicides is ammonium phosphine, which is one of the top three non-selective herbicides in the world. With the ban on paraquat and the problem of resistance to glyphosate, genetically modified ammonium-resistant crops have been promoted for cultivation in some countries in Asia, Europe, Australia, etc., and ammonium has become the second largest herbicide for genetically modified crops in the world. Since refined glyphosate has stronger herbicidal properties and is more cost-effective, it has become the best substitute for ammonium and glyphosate. With the further cultivation and promotion of genetically modified crops resistant to ammonium phosate and the completion of registration and marketing of refined ammonium phosphine by many domestic and foreign companies, the market demand for refined ammonium sulphosate will increase rapidly. Using its technical advantages, the company became the first domestic enterprise to master the key technology for large-scale synthesis of ammonium phosphine and phosphonium nitrate, formed a number of high-value patents, and actively promoted the global layout of patents. The technology is at the leading level in the world. The company has achieved independent support for the main raw materials of the process. High serine has completed production process development and test certification at the company's Mianyang base. At the same time, the company has also mastered the most advanced international production technology for methylphosphine dichloride, another important raw material for ammonium sulphosate. According to the disclosure of the company's plan to issue shares to specific targets in 2023, the company has obtained the original drug registration certificate for refined ammonium sulphosate, and has carried out the strategic layout of ammonium sulphosate globally. As the promotion of genetically modified crops drives the continuous increase in demand for ammonium sulphosate, we are optimistic about the company's technological accumulation and forward-looking layout in ammonium sulphosate. It is expected that the company's market position in ammonium phosphate raw drug products will further improve.

The company has a complete industrial chain of chloropyridine herbicides and has strong integration and technical advantages. The company's chloropyridine herbicides are the main products of toxatrazine, picocloxide, fluorofloxacin, and chlorophyllin. They are conductive, low-toxic, and selective herbicides for internal absorption. According to the company's interim report, global sales of pyridine herbicides increased to US$1,322 billion in 2020, accounting for 4.4% of the global herbicide market, with a compound growth rate of 3.8%. Sales are expected to reach US$1,563 billion by 2025. According to the company's 2023 mid-year report, the company is the first company in the world to fully master the key technology of cyanopyridine chlorination industrialization after Dow Yinong in the US. Currently, the company is the largest R&D and production base for chloropyridine herbicide series pesticide products in China. According to the disclosure of the company's plan to issue shares to specific targets in 2023, the company has formed a complete industrial chain from 2-methylpyridine to 2-cyanopyridine, to pesticide substances such as bicol, toxidine, and chloraminopyridic acid, which can effectively reduce costs, thereby improving the market competitiveness and profitability of picket and pyridine. We are optimistic about the company's integrated industrial chain layout and technical advantages in chloropyridine herbicides, and it is expected that the product market competitiveness will be further enhanced.

The company actively invests in R&D, and its products are widely recognized by downstream customers. According to the company's report, the company is a national high-tech enterprise with a nationally certified enterprise technology center, the Sichuan Functional Heterocyclic Compounds Engineering Technology Research Center, and the Sichuan Heterocyclic Pesticide Engineering Laboratory. It can simultaneously carry out innovative research work on various pesticide raw materials and formulation products, such as new pesticide creation, small test process development, pilot production, formulation development, and bioactivity evaluation. Outstanding R&D capabilities have provided an effective guarantee for the company's product quality, which in turn has accumulated stable downstream customer resources for the company. According to the company's 2023 mid-year report, the company has established stable strategic partnerships with top international agrochemical companies in the industry, such as Codiva, BASF, Syngenta, Newfam, Sumitomo Chemical, and UPL. We are optimistic about the product quality assurance brought about by the company's investment in R&D. It has helped the company establish long-term and stable cooperative relationships with major downstream customers, effectively enhancing the company's market competitiveness.

The company continues to promote the increase of production capacity, and construction projects are progressing steadily. According to the disclosure of the company's plan to issue shares to specific targets in 2023, the company's fund-raising projects include 11,000/year pesticide and supporting facilities construction projects, TCPA sodium salt chemical intermediates and supporting projects, and 10,000 tons/year ammonium sulphosate and public auxiliary projects. The 11,000/year pesticide and supporting facilities construction projects mainly include the 3,000 tons/year fluoride tobacco project, the 3000 tons/year green grass project, the 5,000 tons/year methane project, and related supporting facilities. The construction period of the project is 30 months. It is estimated that after delivery, it can generate annual sales revenue of about 884 million yuan and achieve an average annual net profit of about 115 million yuan after delivery. TCPA sodium salt chemical intermediates and supporting engineering projects can provide stable raw material guarantees for the expansion of downstream chloropyridine products. At the same time, self-production of key intermediates can effectively reduce production costs and further enhance the market competitiveness of downstream products. The construction cycle of this project is 14 months. It is estimated that after delivery, it will generate annual sales revenue of about 535 million yuan and average annual net profit after tax of about 141 million yuan. The 10,000 tons/year ammonium sulphosate refining and auxiliary engineering projects can effectively meet growing market demand and consolidate the company's market position in the phosphonium industry. The construction period of the project is 18 months. It is estimated that after delivery, it can generate annual sales revenue of about 1,504 billion yuan, and achieve an average annual net profit of about 416 million yuan after tax. We are optimistic that the company's new construction projects will be put into operation one after another. We expect that the increase in production capacity will provide a foundation for the continuous increase in the company's revenue.

Investment suggestions: We expect Lear Chemical's revenue for 2023-2025 to be 80.17/89.90/9.610 billion yuan, a year-on-year increase of -20.91%/12.14%/6.89%, and net profit of 6.93/10.25/1,248 billion yuan respectively, a year-on-year increase of -61.74%/47.89%/21.70%, corresponding to EPS of 0.87/1.28/1.56 yuan. Combined with the company's closing price on November 2, the corresponding PE was 14/9/8 times, respectively. We are based on the following five aspects: 1) We believe that global agricultural product prices are still in a good position, farmers' enthusiasm for using drugs is still high, pesticide demand is at a good level, the sharp drop in global pesticide product prices has bottomed out, and the prices of some pesticide types are in the bottom range of history. Looking at the extended cycle, pesticide product prices are expected to gradually rise in the future. 2) As the promotion of genetically modified crops drives the continuous increase in demand for ammonium sulphosate, we are optimistic about the company's technological accumulation and forward-looking layout in ammonium sulphosate. It is expected that the company's market position in ammonium phosphate raw drug products will further improve. 3) We are optimistic about the company's integrated industrial chain layout and technical advantages in chloropyridine herbicides, and it is expected that the product market competitiveness will be further enhanced. 4) We are optimistic about the product quality assurance brought about by the company's investment in R&D. It has helped the company establish long-term and stable cooperative relationships with major downstream customers, effectively enhancing the company's market competitiveness. 5) We are optimistic that the company's new construction projects will be put into operation one after another. It is expected that the increase in production capacity will provide a foundation for the continuous increase in the company's revenue. First coverage, giving a “buy” rating.

Risk warning: risk of raw material price fluctuations, risk of demand falling short of expectations, risk of production safety, environmental risk