Rating: BUY (Initiation)

Target price: RMB232.00

Share price (8 Sep): RMB188.88

Market Cap (RMBm): 14,622.5

Up/downside: 22.8%

Demand for domestic substitution in the industrial sector is strong, ITER project and domestic related projects are coming in, and the new spike in the nuclear industry could lead to long-term high growth. We are optimistic about Guoguang’s sustainable development and initiate coverage with a BUY rating and a target price of RMB232.

Buildup in microwave devices; expanding in response to nuclear market growth

Guoguang’s predecessor was a state-owned factory named 776, established as early as during China’s first Five-Year Plan period. It assisted the Soviet Union to build one of two factories to produce microwave electric vacuum devices and was later restructured into a private sector company. Its business covers the two major technological routes of microwave and vacuum to form three major product applications: microwave devices, nuclear industry equipment and components, and civilian products. Guoguang has grown into a large domestic company that produces vacuum devices and vacuum technology products. It is also the only Chinese private sector company that has independently developed and produced special electric vacuum devices such as traveling wave tubes.

Microwave devices: including microwave electric vacuum devices and microwave solid-state devices. Guoguang is the first domestic manufacturer to develop and produce both electric vacuum and solid-state microwave devices.

Nuclear industry equipment and components: including ITER auxiliary equipment, special pumps and valves used in the nuclear industry. Guoguang’s products are unique as it owns proprietary intellectual property rights, placing it at the tech forefront of the domestic market. It has no domestic competitors with similar products.

Civil market: its core products here are vacuum measurement and control components used in the pressure vessel industry. The company takes the lead in the R&D of wide-ranging, small-volume and remote fax air-monitoring instruments. It produces the only product in China that has passed appraisal by the National Hazardous Chemicals Storage and Transportation Equipment Technology and Information Working Committee with national explosion-proof certification. Its comprehensive strength and profitability have given it domestic and global leadership.

Comprehensive transformation to a significant upward trend in profitability 

2020 revenue was RMB446m, up 25.61% yoy, and net profit was RMB95m, up 126.77% yoy. After a decline in 2018, Guoguang’s net profit growth rates exceeded 100% over two consecutive years and saw a CAGR of 122.4% over 2018-20. 1H21 revenue came to RMB265m, up 26.57%yoy, and net profit was RMB79m, up 72.82%yoy, close to whole-year 2020 level, so we expect high growth to be maintained. In addition, expense ratio in the period declined and expense control improved. In terms of profit margin, as the scale of shipments increased, both gross profit margin and net profit margin were on a rising track. We believe profitability would continue to improve.

Core supplier of vacuum and microwave devices; high-volume nuclear industry 

Guoguang's microwave device business mainly includes vacuum microwave and solid-state microwave devices. Microwave devices are mainly used in the military field and are at the core of military equipment systems such as phased array radar, microwave communications and electronic countermeasures. Compared with solid-state devices, electric vacuum devices have long maintained an advantageous position in the high-frequency range. With the continuous advancement of low-orbit satellite projects, the company's demand for vacuum devices could increase significantly.

Guoguang's nuclear industry equipment and component products mainly include ITER ancillary equipment, special pumps and valves for the nuclear industry. Currently, its nuclear industry products are mainly at the small-batch production and prototype R&D stages. China's nuclear industry is in urgent need of independent innovation and localization in key components. We believe Guoguang's nuclear industry will enter a rapid growth cycle. 

Valuation and risks

Summary: The company is deeply engaged in the segments of microwave devices, with dual drivers in vacuum devices and solid-state devices, especially vacuum devices. With the advancement of electronic countermeasures and low-orbit satellites, we expect the microwave device business to continue to grow, followed by nuclear. Demand for domestic substitution in the industrial sector is strong, ITER project and domestic related projects are coming in, and the new spike in the nuclear industry could lead to long-term high growth. We are optimistic about Guoguang’s sustainable development. 

Valuation: we estimate revenue at RMB661m/980m/1.42bn in 2021/22/23E, net profit at RMB172/299/456m, corresponding to EPS of RMB2.23/3.86/5.90, and PE of 72.74/42.00/27.48x. Relative to average peer PEG, its PE corresponds to 60x in 2022E. We initiate coverage with a BUY rating and a target price of RMB232. 

Risks include: higher customer concentration risks; technological earmarked funds to repay debt could affect cash flow for the company; new product development risks; first wall (FW) and nuclear pump production risks; and short-term share price volatility.

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