Incident: The company announced its 2023 performance forecast. It is expected to achieve net profit attributable to shareholders of listed companies of 310,000 yuan to 350 million yuan in 2023, a year-on-year decrease of 56.33% to 61.32%. Net profit attributable to shareholders of listed companies after deducting non-recurring profit and loss is estimated at RMB 290 million to RMB 330 million, a year-on-year decrease of 57.14% to 62.34%. Affected by factors such as recovering downstream demand and increased market competition, the company's business structure was adjusted, and sales volume and gross margin of the core profit business, the self-produced components business, were phased under pressure, leading to a decline in the company's revenue and net profit to mother. We believe that the company is actively adjusting its marketing strategy to grasp changing demand trends. In the future, as the military boom increases, the company's self-produced components business may gradually resume.

Profitability declined due to pressure on core profit business. Prosperity recovery & new business growth provided considerable flexibility. The cost rate for the first three quarters reached 15.51%, +3.05pct year over year. Among them, the sales/management/ R&D/finance expense ratios were 4.21%/6.95%/3.48%/0.87%, respectively, +0.67/+1.67/+0.17pct, respectively. The sharp increase in the R&D expense ratio and management cost ratio is mainly due to an increase in remuneration and depreciation and amortization. We believe that downstream customer demand has not yet recovered, but the cost rate has risen sharply during the period. As existing business demand warms up and new businesses rapidly climb, the company's cost rate is expected to be effectively controlled during the period.

The first three quarters achieved a gross profit margin of 31.58%, a year-on-year -12.87pct; a net profit margin of 10.61%, or 15.38pct year-on-year. The third quarter achieved a gross profit margin of 20.76%, -26.32pct year on year; achieved a net profit margin of 2.40%, or 22.70pct year on year. The company's core profit business, the self-produced components business, faced a recovery in downstream demand and increased market competition. Sales declined compared to the same period last year, leading to a decline in the overall gross margin of the components business. We believe that the company is actively adjusting its marketing strategy to grasp changing demand trends. In the future, as the military boom increases, the company's self-produced components business may gradually resume. Meanwhile, new businesses with high gross margins are growing rapidly, and the company's profitability is expected to gradually recover.

New business projects under construction accelerated, or opened up the company's second growth curve. As of the third quarter of 2023, fixed assets + projects under construction reached 2,281 billion yuan, up 0.10% from 23H1; fixed assets reached 1,955 billion yuan, +3.62% year-on-year, down 1.77% from 23H1; and projects under construction reached 325 million yuan, +20.74% year-on-year, up 13.06% from 23H1.

According to the semi-annual report, the new materials sector has completed the construction of a liquid PCS production line, and the progress of the second phase of the Liya Tetao plant construction project has reached 90%; the progress of the second phase of the special ceramic material pioneer industrialization project has reached 98%, and the amount of the project under construction increased 1.99 times the initial balance. We believe that the strong and rapid growth in the new materials business will drive the company's ongoing projects to continue to accelerate, and continue to be implemented as production capacity is increased, and the new business direction may open up the company's second growth curve.

Focusing on military MLCCs to consolidate barriers, the layout of active components is expected to open up new performance growth points. As military mechanization, informatization and intelligent construction accelerates, demand for military MLCCs may continue to heat up. In the civilian market, China's MLCC started relatively late. The product line is still dominated by mid-range and low-end conventional categories. The global market share is less than 5%, and there is still a lot of room for civilian MLCCs in the direction of localization. At the same time, the company actively lays out the active power components segment. In April 2023, Shanghai Torch Electronic Technology Group Co., Ltd., a wholly-owned subsidiary of the company, acquired 51% of Xiamen SiC Generation's shares. The business covers IGBTs, MOSFETs and third-generation SiC/GaN power devices. The products are widely used in chargers, motor drives, new energy vehicles, etc., which is expected to open up new performance growth points for the self-produced components business.

The space for high-temperature resistant materials for next-generation weapons and equipment is vast. The new materials are implemented by Liya Group. Among them, the main products of Riya New Materials are CASAS-300 high-performance special ceramic material series products, which are used in the aerospace, aviation, nuclear industries, etc.; the main products of Liya Chemical include solid polycarbon silane, liquid polycarbon silane, etc., which on the one hand can be a pioneer of high-performance special ceramic materials. On the other hand, they can also be used as substrates to manufacture ceramic-based composites. In the first three quarters of 2023, the company's new materials business segment achieved revenue of 137 million yuan, an increase of 112.61% over the previous year, and achieved rapid growth. At the same time, R&D investment continued to increase. In the first half of the year, RIA invested about 28 million yuan in research and development of new materials, an increase of 135.72% over the previous year. The precursor conversion method is the main method for preparing fine diameter (<15 μm) SiC fibers, and so far PCS is still the most successful and representative SiC fiber precursor. SiC fiber is widely used in aerospace and nuclear industries, and is one of the essential key materials for the development of China's aerospace industry. As an upstream, the company is expected to fully benefit, and the market space is broad.

Profit forecast: In summary, with the arrival of a new round of procurement cycles, the company's components business is expected to gradually recover. At the same time, the company's new materials business is growing rapidly. With the accelerated penetration of next-generation materials, the company as an upstream core link is expected to fully benefit, have broad market space, or open up the company's second strategic growth curve. Due to product structure adjustments due to recovery pressure from downstream demand, etc., we adjusted the base figure and adjusted the company's 2023-25 net profit from 10.15/12.56/15.28 to 335/4.91/722 million yuan, corresponding PE to 26.31/17.95/12.21x, maintaining the “buy” rating.

Risk warning: Risk of changes in downstream market demand; risk of declining market share due to market competition; new materials business falling short of expectations, etc.; the performance forecast is only a preliminary estimate. The specific data is based on the company's official 23rd annual report.