Rating: BUY (Initiation) 

Target price: RMB24.00 

Share price (23 Jul): RMB10.76 

Market Cap (RMBm): 3,973.2 

Up/downside: 123.0% 

We initiate coverage with a BUY call and PT of RMB24 (123% upside potential). Due to the supply shortage in 2021, erythritol price continued its boom after the CNY. In 1H21, Baolingbao Biology expects a net profit of RMB47.73~65.09m. 2Q net profit would come to RMB38.90~56.26m (median: RMB47.58), up 62% yoy and 439% qoq. In order to expand capacity further, it plans to raise no more than RMB712m for the erythritol, allulose and other projects via private placement. Full subscription from controlling shareholders implies their confidence on Baolingbao. 

Erythritol: strong demand; capacity shortage continuously boosted prices 

With the trend of sugar-free and low-sugar products, demand for erythritol would continue to grow. Domestic demand will become the core driver for the growth. We expect the CGR of domestic demand in the future to exceed 40%, and the global demand for erythritol would reach 285,000 tons by 2025E. Currently, the market price of erythritol maintained at RMB30,000/ton due to capacity shortage. We believe price will be at a high range. As the higher time costs and uncertainty for new entrants, in the short term, existing companies like Baolingbao Biology will be big beneficiaries. In the long run, cost advantages will become the core competitiveness of those enterprises. 

Allulose: High value-added natural low-calorie sweetener-the next top seller  

With the approval of the US FDA, allulose is currently licensed in 13 countries including Japan, South Korea, Canada, Australia, and New Zealand. Allulose still cannot be used in China. Allulose would see a sales growth in the domestic market if approved by National Health Commission. Currently, domestic manufacturers have begun to expand to this track and companies like Baolingbao Biology have achieved export sales. We expect Baolingbao to complete the trial production of liquid and solid allulose in 2020, which will bring RMB1.12m export sales. It would build a base with allulose (dry basis) capacity of 30,000 tons p.a., as an important component of future core products. 

Beneficiary of sugar-reduction demand 

As a leader in the functional sugar industry, we believe that its core advantages fall on: 1) R&D and innovation: With industry-leading R&D investment, the company participated in making more than 20 industry standards and one international standard, dominating the industry; 2) Supply chain: Currently it is the only one domestic functional sugar manufacturer, covering all functional sugar categories. After the new capacity expansion, its erythritol capacity will reach 60,000 tons and allulose capacity will reach 30,000 tons, fully meeting the growing demand of downstream customers; 3) Brand and market position: The company has continued to strengthen its marketing and promotion for many years, fulfilling customized demand and maintaining strong customer stickiness. 

Valuation and risks 

Excluding additional share dilution, we expect the net profit of RMB200/290/380m in 2021/22/23E, up 302%/47%/28% yoy. Factoring in the rapid growth of the company's future net profit and peers’ valuation, we assign a PE of 30x in 2022E and derive a PT of RMB24, with a target market value of RMB9bn. 

Risks include: fluctuations in downstream customer demand; fluctuations in raw material prices; intensified industry competition; lower-than-expected product sales; approval failure 

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