Incident: On March 19, 2024, Shenma Co., Ltd. released its 2023 annual report. The company's revenue for 2023 was 12.919 billion yuan, down 11.34% year on year; net profit to mother was 123 million yuan, down 69.09% year on year; deducted non-net profit was 62 million yuan, down 83.56% year on year. Corresponding 4Q23 revenue was 3.488 billion yuan, down 7.30% from the previous month; net profit to mother was 53 million yuan, down 49.63% from the previous month.

Comment: Prices of the company's main products fell year-on-year, putting pressure on the company's profit in 2023. The company's overall gross sales margin in 2023 was 12.48%, down 2.36pcts from the same period last year. In 2023, the company's financial expenses increased 7.15% year over year; sales expenses increased 10.27% year over year; R&D expenses increased 3.05% year over year.

The company's net profit declined in 2023, and the net interest rate was 1.63%, down 1.62 pcts from the same period last year.

The company's net profit in 2023 fell 69.09% year on year. The main reason was that the prices of the company's main products, industrial wire, cord cloth, slicing, etc. fell sharply in 2023 compared to the same period due to market reasons, resulting in a sharp decrease in the company's profit compared to the same period.

The company's cash flow changed significantly in 2023. The net cash flow from the company's operating activities in 2023 was 295 million yuan, a year-on-year decrease of 69.28%, mainly due to a decrease in cash received from the sale of goods and provision of services compared to the same period. Net cash flow from investment activities was $3.621 billion, a year-on-year decrease of 57.97%, mainly due to an increase in other cash payments related to investment activities compared to the same period. Net cash flow from financing activities was $3,091 billion, up 52.17% year over year, mainly due to the increase in cash received from investment absorption compared to the same period. The balance of cash and cash equivalents at the end of the period was $7.405 billion, a year-on-year decrease of 2.79%. Accounts receivable increased 10.43% year over year, and accounts receivable turnover declined from 12.24 times in the same period last year to 10.59. Inventory turnover declined from 9.19 to 7.75 in the same period last year.

Establishing a subsidiary of Longan Chemical to improve the ability to guarantee raw materials is expected to enhance the company's profitability. In August 2023, the company announced that it intends to establish a wholly-owned subsidiary, Henan Shenma Longan Chemical Co., Ltd., in Shilong District, Pingdingshan City, Henan Province, to prepare a 40000Nm3/h coke oven gas comprehensive utilization project. Longan Chemical uses coke oven gas resources from coking companies around the location to carry out deep processing of coke oven gas to produce liquid ammonia and LNG products, which can not only improve the comprehensive utilization value of wealthy gas, but also improve the atmospheric environment, optimize the energy structure, reduce coal consumption, supplement natural gas supply and supply, improve the raw material guarantee capacity of the nylon industry chain, and reduce production costs. After completion, this project will increase the company's product range, enhance its economic strength and competitiveness, and promote the development of the regional economy.

It is planned to build a nylon 66 production base with an annual output of 20,000 tons in Thailand to continue to advance overseas strategic layout. On January 19, 2024, the company issued the “Notice of Shenma Co., Ltd. on investing in a new production base in Thailand”. It plans to invest in the construction of 20,000 tons/year nylon 66 differentiated fiber Thailand project (phase 1) to form a total construction scale of 7,000 tons/year nylon 66 industrial wire and 3,000 tons/year nylon 66 fine denier wire totaling 10,000 tons/year nylon 66 differentiated fiber. The total investment of the project is about 255 million yuan, and the construction period is 15 months. The implementation site is located in the “Eastern Economic Corridor” of Thailand. The company responded positively to the national “Belt and Road” cooperation initiative and established a nylon 66 industrial wire production base in Thailand, which helps the company accelerate the internationalization process, meet the needs of international customers, and improve the supply capacity of products in the global market. The United States is the world's largest tire consumer market. Thailand and Vietnam are the main sources of increased tire imports. Many well-known tire companies from around the world and China have invested in setting up automobile tire processing bases in Thailand, and the Southeast Asian factory has become the main source of output value and profit for leading Chinese tire companies. The company closely follows market trends and has set up an industrial yarn and cord cloth production base in Thailand to meet the growing demand of the tire manufacturing industry in Southeast Asia. At the same time, the supply network can also radiate neighboring countries such as India to maintain and consolidate the company's position in the nylon industry market. We believe that the gradual improvement of the company's overseas production capacity layout for nylon 66 fiber will help it develop overseas markets, enhance global sales capacity, increase radiation penetration in key overseas regions, and avoid high anti-dumping duties, which is of great significance to the safety and stability of the company's supply chain.

Increase capital to build the second phase of the nylon 6 civil wire project to expand the overall layout of the nylon industry. On March 12, 2024, the company issued the “Notice of Shenma Co., Ltd. on the capital increase of Henan Shenma Nylon Technology Co., Ltd.” with Fujian Hengshen Synthetic Fiber Technology Co., Ltd. and Pingdingshan Dongxin Coking Co., Ltd. to increase the capital of nylon technology according to the shareholding ratio for the 100,000 tons/year nylon 6 civil wire phase II (60,000 tons/year) project. The total capital increase is 200 million yuan, and the company's shareholding ratio is expected to reach 48.96% after the capital increase is completed. It is beneficial for nylon technology to further expand its business scale and speed up project construction. The nylon 6 civil wire phase II project can enable the company to give full play to the raw material advantages of existing nylon 6 slices and further enter the field of nylon 6 civil wire and nylon 6 differentiated fibers. It will also help the company to make early use of the synergetic advantages of the nylon 6 industry chain, develop the nylon 66 and nylon 6 double nylon industry, and fully release the additional benefits of the industrial chain. We believe that this capital increase can speed up the commissioning of the company's nylon 6 civil wire project, further stabilize the company's nylon industry trend, enhance the company's profitability, and benefit the company's performance and future development in the long run.

Investment advice: The company is expected to achieve operating income of 157.68/183.55/ 21.051 billion yuan in 2024-2026, respectively, and realized net profit of 3.74/6.40/797 million yuan, respectively. The corresponding EPS is 0.36/0.61/0.76, respectively. The PE multiples corresponding to the current stock price are 19.3X, 11.3X, and 9.1X, respectively. We are based on the following aspects, 1) After Longan Chemical's 40000Nm3/h coke oven gas comprehensive utilization project and the nylon chemical industry's coal-to-ammonia project are put into operation, the company's raw material supply will be guaranteed and procurement and production costs will be effectively controlled to give full play to the synergetic advantages of the entire industry chain; 2) The company continues to improve the overseas nylon 66 production capacity layout to ensure its supply capacity in the global market, which is beneficial to the company's performance; 3) The company's capital increase accelerates the commissioning of the nylon 6 civil wire project, which is beneficial to the company's performance. Overseas production capacity investment maintains a “buy” rating.

Risk warning: risk of product price and macroeconomic fluctuations; risk of raw material price fluctuation and supply risk; risk of increased market competition; downstream demand falling short of expectations; risk of exchange rate fluctuations.