Incident: On October 28, 2024, Huaheng Biotech released its 2024 three-quarter report. The company's revenue for the first three quarters of 2024 was 1.539 billion yuan, up 12.82% year on year; net profit to mother was 0.17 billion yuan, down 46.90% year on year; after deducting non-net profit of 0.166 billion yuan, down 47.41% year on year. Corresponding to 3Q24, the company achieved operating income of 0.523 billion yuan, up 1.66% year on year, up 1.43% month on month; net profit to mother was 0.02 billion yuan, down 84.32% year on year, down 68.04% month on month.

Comment: The company's performance in the first three quarters of 2024 was under pressure, and valine prices declined. The company's overall gross sales margin for the first three quarters of 2024 was 28.13%, down 13.16 pcts from the same period last year. In the first three quarters of 2024, financial expenses increased 663.31% year over year; sales expenses increased 33.43% year over year; management expenses increased 24.18% year over year; and R&D expenses increased 17.07% year on year. The company's net interest rate for the first three quarters of 2024 was 10.92%, down 12.49pcts from the same period last year. The main reason for the decline in the company's net profit in 3Q24 was that the price of valine products fell compared to the same period last year. At the same time, the company's business scale continued to expand, and related expenses increased compared to the same period last year.

The company's cash flow from operating activities declined year-on-year in the first three quarters of 2024. The net cash flow from the company's operating activities in the first three quarters of 2024 was 0.105 billion yuan, a year-on-year decrease of 71.73%, mainly due to an increase in cash for purchasing goods and receiving labor payments. Net cash flow from investing activities was -0.631 billion yuan, up 18.51% year over year. Net cash flow from financing activities was $0.61 billion, an increase of 40.87% over the previous year. The balance of cash and cash equivalents at the end of the period was $0.445 billion, up 145.86% year over year. Accounts receivable amounted to $0.231 billion, up 15.98% year over year, and accounts receivable turnover increased from 5.94 times in the same period in 2023 to 6.46 times. The inventory turnover rate declined from 5.27 times in the same period in 2023 to 3.81 times.

The company's product matrix continues to be rich, and the downstream market is favorable to product launch. According to Wind data, the average market price of 3Q24 valine/inositol was 13.66/46.86 yuan/kg, respectively, and -34.07%/-67.24%, respectively. Since the first quarter of 2024, the price of valine products has continued to decline. Currently, it has fallen to the bottom range, and there is limited room for decline. At the same time, the company mass-produces fermented L-valine products on a large scale at its Bayannaoer base, which has the highest production capacity in the industry, and market share and product sales are expected to continue to grow. In addition, the company's new products, such as 1,3-propanediol, succinic acid, malic acid, tryptophan, and arginine, were put into production according to plan, and the company has accumulated high-quality customer resources in downstream markets in many related fields, laying a good foundation for the marketing of new products. We believe that the expansion of business scale and the steady progress of diversification of product categories are expected to hedge against the impact of falling prices of main products, make up prices with volume, and the company's performance is expected to pick up.

Soybean meal substitution boosts demand for amino acid products. In terms of amino acid products, in the face of the promotion of precise nutrition, low-protein diet, and soybean meal reduction and substitution actions, and the weak operation of the breeding industry, the mixed meal+amino acid plan is expected to accelerate the demand to replace part of the soybean meal, and the demand for amino acids will further increase. Currently, the soybean supply situation remains relaxed, but the cost of imported soybeans has rebounded slightly, and the price gap with domestic soybeans has narrowed, and demand for domestic high-oil soybeans has been boosted to a certain extent. Domestic and foreign soybean meal futures fluctuate, and when combined with expectations of a reduction in foreign soybeans, the prices of soybeans and soybean meal will rise somewhat, further driving the increase in demand for amino acids. We believe that this trend will have a positive impact on the amino acid market, drive demand for related products and industry development, and bring broader development space and opportunities to the amino acid market.

Establish a bio-based polyester textile industry alliance to strengthen upstream and downstream collaborative innovation in the PDO-PTT industry chain. On September 26, 2024, the “Bio-based Polyester Textile Industry Alliance” led by the company was formally established in Hefei, Anhui. As a key raw material for bio-based polyester PTT, the stable supply of 1,3-PDO has been dominated overseas for a long time.

The company's 0.05 million tons of bio-based 1,3-PDO has established advantages in product quality, supply stability, cost, etc., and has achieved full localization of the “PDO - PTT polymerization - spinning - functional fiber - fabric - end product” industrial chain. We believe that the establishment of this alliance can promote domestic substitution of raw materials and the breakdown of the core materials industry in an orderly manner, achieve upstream and downstream integration, drive stock development through an incremental model, and push the bio-based fiber industry chain into a stage of high-quality growth.

Targeted additional capital raising to support sustainable development with supplementary funds. According to the “2022 Notice of Issuance of A Shares to Specific Targets and Changes in Share Capital” issued by the company on October 30, 2024, a total of RMB 21.1225 million common shares were issued, with an issuance scale of approximately 0.7 billion yuan. The capital raised this time is mainly used for the company's “project to build a production base with an annual output of 0.05 million tons of bio-butyric acid and raw materials for bio-based products”, “a bio-based malic acid production and construction project with an annual output of 0.05 million tons” and supplementary working capital. We believe that this targeted increase can ease the company's financial pressure, help the company maintain stable cash flow, further open up space for diversified product categories, and enable the company's performance growth.

Investment advice: The company is expected to achieve operating income of 2.46/3.477/4.613 billion yuan in 2024-2026, and realized net profit of 0.259/0.385/0.457 billion yuan respectively, corresponding EPS of 1.13/1.68/2.00 yuan, respectively. The PE multiples corresponding to the current stock price are 26.0X, 17.6X, and 14.8X, respectively.

We are based on the following aspects: 1) the company's new products are introduced to the market in an orderly manner, and the scale of operation continues to expand, releasing profit flexibility; 2) the production capacity of the main products is stable, and there is limited room for downward valine prices, which is expected to achieve volume compensation; 3) the company strengthens upstream and downstream collaborative innovation in the PDO-PTT industry chain, and supplementary funding supports production construction and production capacity expansion, and the performance is expected to continue to recover. We are optimistic about the expansion of the company's product matrix and the development prospects of PDO products, and maintain a “buy” rating.

Risk warning: core technical risks; raw material price fluctuation risks; market competition risks; overseas sales risks; risks of projects under construction falling short of expectations; safety and environmental risks, etc.