Business model: Shifting to asset-light, the product focuses on high-margin diagnosis and diagnostic upgrades Yuanzheng Technology develops a series of professional equipment for automobile diagnosis, inspection and maintenance, lifts, etc. Among them, X-431 products represent the advanced level of domestic diagnostic technology. The company uses diagnostic equipment to connect with more than 0.3 billion vehicles around the world, with a market share of 70% in the domestic market. The average daily automobile diagnosis report reached 0.8 million, and the cumulative diagnostic report reached 1.3 billion shares.

By the end of 2023, the number of NEVs in China had surpassed 20 million units. The company focused on promoting new products for NEV fault diagnosis, such as SDS (remote diagnosis, intelligent diagnosis), EVS (sales service), and AAS (interactive service with customers to efficiently promote maintenance, etc.), covering the entire life cycle of new energy vehicles, and the service satisfaction of users with new products exceeded 90%. Currently, NEV maintenance is still in the early stages (few holdings, low maintenance requirements).

Change: Cut out low-margin product lines and focus on providing better diagnostic and maintenance technology and services downstream.

The advantages of being light on assets are:

1) Focus more on R&D and design of new products, and focus on building high-end brand power; 2) Adjust product categories and production capacity more flexibly (help avoid US export trade risks); 3) Reduce capital expenses and increase net cash flow.

H1 gross margin increased by 7pct to 47% in '24, benefiting from the share of overseas/software revenue and increased profit flexibility1: Increased overseas investment and a high increase in overseas business

In recent years, the company has continued to expand overseas channels, and held an annual meeting for overseas dealers in '23, which has strongly promoted overseas business development. 24H1's overseas business (including overseas e-commerce) revenue was 0.629 billion yuan, yoy +90%. Thanks to strong channel development, the revenue share increased to 63% (42% and 45%, respectively, in 22/23). Markets represented by the US have strong consumption capacity (low price sensitivity).

Profit Elasticity 2: Software Release, Product Shrinkage with Poor Profitability

The company promotes separate sales of diagnostic equipment and diagnostic software. Customers can choose to buy diagnostic software and renew upgrades online. Based on the high convenience and economic advantages of remote diagnosis, customer willingness to purchase continues to increase.

In '23, software revenue contributed 0.127 billion yuan, +49% year over year. The number of customers who paid to buy software increased 106% year over year, the number of customers who paid to upgrade software increased 72% year over year, and the number of paid devices was nearly 0.04 million; remote diagnosis orders grew rapidly, with 0.73 million orders issued throughout the year, an increase of 91% year over year.

The gross margin of the software category is usually much higher than 50%, and the net margin conversion rate is impressive.

Investment advice

The company's growth has benefited from a steady increase in NEV ownership and maintenance requirements. At the same time, with 1) vigorous development of overseas business, an increase in the share of overseas revenue, 2) an increase in the share of software business, an increase in profit levels, and a high dividend payout rate.

We expect the company's net profit to reach 0.3 and 0.39 billion yuan in '24 and '25. The current market capitalization is 6/5X PE, respectively, and the target price is HK$10.75, which is covered for the first time, giving it a “buy” rating.

Risk warning: New product sales fall short of expectations, overseas expansion falls short of expectations, competition intensifies