Event: On April 26, 2024, Lianhua Technology released its 2023 annual report. The company's revenue in 2023 was 6.442 billion yuan, down 18.10% year on year; net profit to mother was -0.465 billion yuan, down 166.76% year on year; net profit after deducting non-net profit was -0.354 billion yuan, down 169.69% year on year. The corresponding company's 23Q4 revenue was 1.424 billion yuan, up 5.24% month on month; net profit to mother was -0.39 billion yuan, down 290.05% month on month.

Incident 2: On April 26, 2024, Lianhua Technology released its 2024 quarterly report. The company's 1Q24 revenue was 1.466 billion yuan, down 25.12% year on year and up 2.93% month on month; net profit to mother was 0.003 billion yuan, down 93.96% year on year, up 100.69% month on month.

Comment: Inventory removal in the plant protection industry compounded losses at the UK base, putting pressure on the company's 2023 performance. The company's revenue in the pharmaceutical/pesticides/functional chemicals sector in 2023 was 1.482/4.243/0.189 billion yuan, YoY was 1.01%/-26.74%/-14.68%, respectively, gross margin was 34.82%/14.32%/15.50%, respectively, and YOY was +1.77/-10.59/-5.28pcts, respectively. In terms of sales, the company's sales volume of plant protection products was 0.0247 million tons, down 25.75% year on year. This was mainly due to the plant protection industry's inventory removal; sales volume of pharmaceutical products was 708.8 tons, down 40.35% year on year, mainly due to a decrease in orders for some lower-priced products. Sales volume of functional chemicals was 0.0118 million tonnes, down 6.46% year over year. The company's revenue and profits are under pressure in the short term. The main reason for this is the decline in orders due to the plant protection industry entering the storage cycle and losses at the UK base. In 2023, Lianhetech Holdco Limited's revenue was 0.584 billion yuan and net profit was -0.676 billion yuan. The main reason for this was that the British subsidiary needed to repay interest on loans from within the company and insufficient capacity utilization due to the impact of the “inventory removal” market. The company's sales expenses increased 163.00% year on year, the sales expense ratio was 0.51%, up 0.35 pcts year on year; management expenses decreased 1.00% year on year, management expenses rate was 12.07%, up 2.08 pcts year on year; financial expenses decreased 56.05% year on year, financial expenses rate was 0.33%, down 0.28 pcts year on year; R&D expenses decreased 4.81% year on year, and R&D expenses rate was 5.83% year on year, up 0.81 pcts year on year.

The plant protection industry is still in the inventory removal cycle, and the 1Q24 company's performance was still under pressure year over year, turning losses into profits month-on-month. According to the company's investor exchange minutes of May 22, 2024, the main reason for the year-on-year decline in the company's performance in 1Q24 was a decrease in the number of some of the company's orders due to “inventory removal” from customers. The company expects that in the second half of 2024, the “de-inventory” market trend in the plant protection industry will slow down. From the perspective of financial statements, the plant protection industry's “de-inventory” cycle is gradually ending, and the company expects to reflect this in the 2025 financial statements.

The company's various net cash flows have changed significantly. Net cash flow from the company's operating activities in 2023 was $1.077 billion, up 68.67% year on year; net cash flow from investment activities was -1.073 billion yuan, up 37.96% year on year; net cash flow from financing activities was $0.128 billion, down 87.81% year on year. The balance of cash and cash equivalents at the end of the period was $0.596 billion, up 27.07% year over year. Accounts receivable decreased 24.17% year over year, and the accounts receivable turnover rate declined, from 5.62 times in the same period in 2022 to 4.99; inventory fell 10.00% year on year, and inventory turnover decreased, from 2.25 times in the same period in 2022 to 1.87 times.

Short-term overcapacity combined stocks are at a high level, and the pesticide industry pattern needs to be reshaped. Pesticide demand is still resilient in the long run. Domestic pesticide production capacity is concentrated, and the overall market shows a situation where supply exceeds demand. Inventory within superposition channels is still high, competition in the pesticide market has intensified, and product prices have dropped sharply. According to data from Zhongnong Lihua, as of May 26, 2024, the CNPC original drug price index was 77.38 points, down 13.2% from last year and 0.62% from the previous month. Of the hundreds of pesticide raw drug products tracked, 77% of the product prices fell compared to last year. As mergers and acquisitions of leading agrochemical companies come to an end, multinational companies such as Syngenta Group, Bayer, BASF, and Cody Huawei Group 1 will account for more than 60% of the global pesticide market. The upstream intermediate and drug supplier pattern will also show a concentrated trend. After optimizing production capacity, companies without a competitive advantage will withdraw from the market, leading companies will receive more orders, and the pesticide industry pattern will gradually improve. In the long run, as the world's population increases and the amount of cultivated land per capita decreases, food security issues are becoming more and more prominent, and people are placing higher demands on the yield of crops per mu. Pesticides play an obvious role in improving food production efficiency, and the market size continues to expand. According to S&P Global Commodity Insights data, the global pesticide market grew from US$35.575 billion to US$87.7 billion from 2006 to 2022, with a compound annual growth rate of about 5.80%. We believe that the continued increase in demand for pesticides and the reshaping of the supply pattern will drive pesticide prices to gradually return to a reasonable position.

The company continues to invest in technology and the global supply chain, and the competitive advantage of the plant protection industry is obvious. According to the company's 2023 annual report, in terms of technology, the company has built multi-level technology research and development platforms such as the Shanghai R&D Center, Taizhou R&D Center, and the technical department of the base, which fully matches the different needs of customers in the early stages of molecular screening, development, marketing, growth period and maturity period, and provides customers with one-stop services from milligram level R&D and kilogram scale pilot scale to commercial production above 100 tons. In terms of supply chain, the company has multiple production bases across the country and overseas bases in the UK. At the same time, it actively lays out a second overseas base, and finally determined Malaysia as an overseas location with a “differentiated supply chain layout”.

The company has become an important strategic supplier to the top 5 companies in the plant protection industry, and is actively expanding cooperation in the field of “biochemical” plant protection. Currently, a series of projects have entered the product incubation pipeline. We are optimistic about the company's continued investment in technology research and development and global supply chain layout, and it is expected that the competitiveness of the company's plant protection products will be further strengthened.

Many of the company's products in the pharmaceutical field have entered the clinical and commercialization period, providing a guarantee for the company's performance. The company actively participated in the development and cooperation of innovative drugs, and has prepared a number of clinical phase II and III pipeline products with great commercial potential. According to the company's 2023 annual report, the number of commercialized/clinical phase III/other clinical stage products in the company pipeline in 2023 was 19/31/62, with a year-on-year change of 1/-8/-5. The revenue from commercial/clinical phase III/ other clinical stage products was 1.041/0.375/0.066 billion yuan, respectively, and YoY was 1.35%/20.91%/-49.01%, respectively. In 2023, the company underwent about 20 quality system audits by domestic and foreign regulatory agencies and well-known pharmaceutical companies and multinational chemical companies. The company's Eguchi plant and the UK factory have both passed FDA audits, and the Eguchi plant has passed the EU EMA audit. Taizhou Lianhua, a subsidiary of the company, successfully passed the TGA audit. In 2023, it passed the US FDA (Food and Drug Administration) inspection with zero defects, and passed the PMDA (Japan Pharmaceutical and Medical Device Comprehensive Review Agency) on-site inspection. At the same time, Taizhou Lianhua obtained several documents certifying the export of raw materials to the EU. Furthermore, the company established a new CRO base in 2023 and continues to expand in the fields of peptide technology and amino acid research and development. We are optimistic about the rich product reserves in the company's pharmaceutical pipeline, and the sector's performance is expected to rise steadily.

In the field of functional chemicals, the company focuses on the field of new energy, and many products are ready to be launched. According to the company's 2023 annual report, there are 4 new energy products in the company's pipeline that are undergoing commercial trial production and are preparing to be introduced into the market, 1 product will be scaled up after completing the pilot test, 4 products in the pilot phase, and 10 products tested in the small test phase. As the two major electrolytes, lithium salt, are completed one after another in the future, and after customer verification and introduction into the market, the company will continue to make efforts in electrolytes, electrolyte main salt products, functional additive products, and solvent products that match the next generation of electrochemical systems to complete the corresponding industrial chain layout. We are optimistic about the company's layout and development in the field of new energy products, and it is expected to increase the company's performance in the future.

The company accelerated project construction, and several projects obtained EIA approval. According to the company's 2023 annual report, the company has a production capacity of 600 tons of herbicides and intermediates, 50 tons of pesticides and intermediates, and 145,000 tons of functional chemicals. The company obtained a new “annual output of 0.2 million tons of electrolyte, 0.02 million tons of LT612, 1,411 tons of lithium hydroxide solution, 500 tons of tri (trimethylsilyl) phosphate, etc.”, “annual production of 15 tons of chloropyrazine, 15 tons of spirocycloquimide hydrochloride, 8 tons of acrylic anhydride, 20 tons of pyrimidine amide, 50 tons of quinoline propionate sodium salt, 0.5 tons of crizolitiniol technical improvement project”, “LT533 technical improvement project with an annual output of 50 tons”, and “50 tons of annual output of 50 tons of vibergeron intermediates”, “Annual production of 140 tons The “LT442 project” and the “technical improvement project with an annual output of 250 tons of aminofluoric acid methyl ester hydrochloride (LT668)” have been approved, and the NE128 technical improvement project with an annual output of 600 tons is being applied for EIA approval. We are optimistic about the progress of the company's project construction. The completion of the project is expected to increase the company's performance.

Investment advice: We expect Lianhua Technology's revenue for 2024-2026 to be 6.717/7.858/9.472 billion yuan, up 4.3%/17.0%/20.5% year-on-year, and net profit to mother of 0.129/0.361/0.619 billion yuan, respectively, up 127.8%/179.0%/71.5% year-on-year, and corresponding EPS of 0.14/0.39/0.67 yuan respectively.

Combined with the company's closing price on June 5, the corresponding PE was 39/14/8 times, respectively. We are based on the following five aspects: 1) We believe that the continued growth in pesticide demand and the reshaping of the supply pattern will drive pesticide prices to a reasonable position gradually. 2) We are optimistic about the company's continued investment in technology research and development and global supply chain layout, and it is expected that the competitiveness of the company's plant protection products will be further strengthened. 3) We are optimistic about the rich product reserves in the company's pharmaceutical pipeline, and the sector's performance is expected to rise steadily. 4) We are optimistic about the company's layout and development in the field of new energy products, and it is expected to increase the company's performance in the future. 5) We are optimistic about the company's project construction progress. The completion of the project is expected to increase the company's performance and maintain a “buy” rating.

Risk warning: raw material price fluctuation risk, demand falling short of expectations risk, project construction risk, environmental policy risk