Incident: The company released its 2024 mid-year report, achieving revenue of 1.36 billion yuan, -0.7% YoY; net profit to mother of 0.14 billion yuan, or -25.3% YoY. In the 2024Q2 quarter, the company achieved revenue of 0.72 billion yuan, +0.8% year-on-year; net profit to mother was 0.06 billion yuan, or -38.5% year-on-year. Results for the first half of the year fell short of market expectations, and net profit was under pressure in the short term.

Unit prices are under pressure due to falling raw material prices, and trade customers are growing rapidly. 1. By product, 24H1 crystal sugar alcohol achieved revenue of 0.94 billion yuan, or -6.3%; liquid sugar alcohol and others achieved revenue of 0.33 billion yuan, or -7.8% year over year.

The company's overall sales volume remained relatively stable. The year-on-year decline in revenue in the first half of the year was mainly due to the fact that Q1 had a high base last year due to a high increase in overseas orders, while demand in the Q1 market became more stable this year, and at the same time, product unit prices were adjusted due to falling raw material prices. 2. By region, 24H1 achieved revenue of 0.75 billion yuan, +13.6% year-on-year; overseas revenue of 0.61 billion yuan, or -14.0% year-on-year. During the same period last year, due to geopolitical factors, European energy costs were high, and production and costs of related sugar alcohol companies were affected. The company quickly transferred industry dividends to achieve a high increase in overseas business. This year, the company continued to be deeply tied to major overseas customers, and remained steady against the backdrop of last year's high growth rate. 3. By channel, 24H1 direct sales customer revenue was 1.19 billion yuan, -3.3% year over year; trade customer revenue was 0.17 billion yuan, +21.5% year over year. In the first half of this year, the company added 18 new domestic traders and 11 new overseas traders. On the premise of doing a good job in maintaining the original customers, we promptly followed up on the needs of major customers and carried out in-depth strategic cooperation with major customers. The company relies on the geographical advantages of Zhoushan Huakang to expand its sales radius, develop potential target markets around existing customer channels, and formulate targeted sales plans according to different customers and markets to fully prepare for project implementation in the second half of the year.

Profits are under pressure in the short term, and equity incentives help medium- to long-term development. 1. 24H1's overall gross profit margin was 21.6%, down 2pp year on year; net profit margin was 10.2%, down 3.3pp year on year. The decline in gross margin in the first half of the year was mainly due to a decrease in profits due to an increase in current equity incentive amortization expenses and construction costs for the Zhoushan Huakang project, which affected the subsequent decline in net interest rates. 2. The sales/management/R&D expense ratios of the 24H1 company were 1.8%/4.6%/4.7%, respectively, compared with +0.4 pp/+1.9 pp+0.4 pp. It is expected that after excluding the impact of share payments and the successful completion of the Zhoushan project in the second half of the year, the management fee ratio will be optimized to improve overall efficiency. 3. The net cash flow generated by 24H1 from operating activities was -0.06 billion yuan, a decrease of 0.31 billion yuan compared with the same period last year, mainly due to a decrease in cash received from the sale of goods and provision of services due to high overseas financing costs and reduced receivables financing.

The first phase of the Zhoushan project has entered a critical stage of construction, and the 100-day campaign is ready to go. The “2 million ton corn deep processed health food ingredients project” was built in two phases. The first phase of the “1 million ton corn deep processing health food ingredients project” was launched in August 2022, and the first phase of 2 years is about to be completed. The production capacity of this stage is mainly liquid syrup and some crystalline sugar alcohol products. In June of this year, Zhoushan Huakang held a 100-day offensive pledge conference and sounded the “100 days of hard work”. Currently, the project has reached the critical stage of equipment installation and commissioning. The company will steadily face the difficulties and pain points in the project construction process, rise to the challenges in the offensive battle, and ensure that the project construction is completed on time. After that, the second phase of construction, which lasts for 3 years, is about to begin, and new product lines such as dietary fiber and modified starch will be put into construction one after another.

Profit forecasting and investment advice. As a leader in functional sugar alcohol, Huakang Co., Ltd. continues to enrich and optimize the product structure, expand internally and externally, lay out new tracks, continue to implement high-margin single product production capacity, and has excellent growth. Despite being affected by short-term cyclical fluctuations, the return on the medium- to long-term company's crystalline sugar alcohol business is still impressive. Combined with the rapid release of production capacity implementation results in the first phase of the Zhoushan project, I am optimistic that subsequent companies' sugar alcohol business will continue to develop. It is estimated that in 2024-2026, the company's net profit to mother will be 0.3 billion yuan, 0.38 billion yuan, and 0.44 billion yuan, respectively, and the corresponding EPS will be 0.98 yuan, 1.26 yuan, and 1.45 yuan, respectively. The company was given a valuation of 15 times in 2024, corresponding to a target price of 14.7 yuan, maintaining a “buy” rating.

Risk warning: risk of low market demand; risk of raw material supply and price fluctuations; risk of exchange rate fluctuations; risk of production capacity falling short of expectations.