Yuanli has been deeply engaged in wood-based activated carbon for over two decades and has established a solid revenue foundation based on wood-based activated carbon and silicides. Through the development of new energy materials such as supercapacitor carbon, hard carbon, and silicon carbon, Yuanli has been continuously building a second growth curve. In 2022, the Company maintained high growth rates. Though faced with short-term pressure in 1Q23, Yuanli posted a significant improvement in earnings in 2Q23. We are optimistic about the Company's development prospects in the field of new energy carbon materials, which may drive both revenue and net profit growth. We revise its 2023E/24E/25E EPS estimates to Rmb0.71/0.94/1.25 (vs previously Rmb0.73/0.93/1.24). We adopt the sum-of-the-parts (SOTP) valuation framework and assign a target market cap of Rmb8.2bn for 2023 while raising the target price to Rmb23 (vs previously Rmb22). We reiterate the "BUY" rating.

1H23 earnings came in line with expectations, with a significant improvement in 2Q23 earnings.

Yuanli achieved revenue of Rmb960mn (-3.1% YoY) in 1H23 and attributable net profit (ANP) of Rmb114mn (+0.4% YoY). In a breakdown by quarters, both 1Q23 and 2Q23 posted revenue of Rmb457mn (-6.7% YoY) and Rmb502mn (+0.4% YoY), and ANP of Rmb45mn (-10.9% YoY) and Rmb68mn (+9.7% YoY). In terms of business segments, the wood-based activated carbon segment achieved revenue of Rmb597mn in 1H23 (+0.2% YoY) with gross profit margin (GPM) of 27.70% (-1.65ppts YoY). The sodium silicate segment posted revenue of Rmb293mn (+5.1% YoY) with GPM of 9.32% (-0.84ppts YoY). The silica gel segment recorded revenue of Rmb69mn (-35.4% YoY) with GPM of 31.40% (-2.40ppts YoY). The Company's GPM for 1H23 was 22.36%, with 21.65% for 1Q23 and 23.0% for 2Q23, indicating a quarterly improvement trend.

Yuanli plans to launch a medium and long-term equity incentive plan for partners to strengthen the Company's sustainable development.

On Jul 10, 2023, the Company issued an exposure draft on launching the medium and long-term equity incentive plan for partners with a duration of ten years (2024-2033). The plan will be implemented in stages, with each stage being established independently and rolling over each year. The specific participants and amount of funds for each stage will be determined by the board of directors based on the actual needs of attracting, motivating, and retaining key talents each year. According to the plan, the cumulative total shareholding of participating individuals at any time points shall not exceed 10% of the total share capital, and the cumulative shareholding at any given time points shall not exceed 1% of the total share capital. This plan aims to strengthen the long-term alignment of interests between the Company and its employees, enhance internal motivation, mobilize the enthusiasm of the core management team, and activate the long-term growth potential of the Company.

Yuanli has been strengthening its leading position in the wood-based activated carbon industry and expanding its application areas.

By the end of 2022, Yuanli's wood-based activated carbon production capacity had exceeded 120kt, with a stable market share of over 30% and a continuously expanding leading advantage. In addition to traditional applications in food & beverage, the Company has been continuously exploring new application areas for wood-based activated carbon. This includes steadily venturing into the pharm activated carbon market and vigorously expanding its presence in the gas-phase adsorption field. The Company's bamboo-based granular carbon has been undergoing a systematic capacity expansion, with the potential to gradually replace coal-based activated carbon in the environmental protection field currently dominated by coal-based activated carbon. This allows the Company to benefit from the high growth rate of the environmental activated carbon industry.

The industrialization process of sodium-ion batteries is accelerating with promising long-term development prospects.

1) In the field of electric two-wheelers: Since the start of 2023, companies such as Yadea, Suzuki, and Sunra have successively released electric two-wheelers equipped with sodium-ion batteries. Companies like Tianneng Battery, Chilwee, and Phylion Battery have also released sodium-ion batteries suitable for electric two-wheelers. 2) In the field of new energy vehicles (NEVs): In the 372nd announcement on on-road motor vehicle manufacturers and products released by the Ministry of Industry and Information Technology (MIIT) in Jun 2023, two models with sodium-ion batteries were included for the first time. They are the Chery QQ Ice Cream electric vehicle (EV), a collaboration between Chery Automobile and Contemporary Amperex Technology (CATL), and the Yichi Jade Rabbit EV, a collaboration between Jiangling Motors and Farasis Energy. 3) In the field of new energy storage: Companies such as HiNa Battery, Great Power Energy, and BYD have implemented sodium-ion battery energy storage projects with a capacity of tens of megawatt-hours. Energy storage companies such as Hello Tech Energy, Pylon Technologies, and Reliance Energy Storage have also entered the sodium-ion battery market. Driven by these three major application scenarios, the industrialization of sodium-ion batteries is accelerating, with broad development prospects ahead.

The fast-charging trend in power batteries is gaining momentum, and the penetration rate of silicon-carbon anodes may continue to rise.

The driving range and charging efficiency are the major factors influencing consumer NEV purchases. Fast-charging technology has become a standard feature in middle and high-end NEV models and has become a new competition focus among power battery manufacturers. CATL's Qilin battery has entered mass production in 1Q23 and has made certain changes to battery system structure compared to the commonly used 2C charging system (delivering 2A for 30m). According to the plans of Li Auto and other automakers, the penetration rate of the batteries with 4C fast-charging capability (delivering 4A for 15m) may continue to increase going forward. The anode material is crucial in determining the charging rate of batteries. The use of three technological approaches, namely, secondary granulation, carbon coating, and silicon-carbon anodes, bodes well for accelerating lithium-ion migration and extraction, improving lithium storage capacity, as well as suppressing lithium plating effect, and stabilizing the solid electrolyte interphase (SEI) layer and material structure.

Yuanli has been industrializing new energy carbon materials, aiming to create a second growth curve for the Company.

In Jan 2023, Yuanli's wholly-owned subsidiary, Yuanli New Energy Carbon Materials (Nanping), was established. Leveraging its accumulated expertise in carbon materials, the Company has been accelerating the development of its competitive position in the application of carbon materials in the field of new energy. Currently, projects such as supercapacitor carbon, hard carbon, and silicon-carbon anode materials have been progressing in an orderly manner.These projects stand well to benefit from the industrialization of sodium-ion batteries and the increasing penetration rate of fast-charging in power batteries. 2023 is likely to be the year of production ramp-up for the Company's new energy carbon materials, creating new growth opportunities for the Company.

Creating a circular economy for the four industries of bamboo, carbon, silicon and energy, and continually reducing costs and enhancing efficiency via green development.

By focusing on the construction of a circular industrial park, Yuanli aims to achieve cost reduction and efficiency enhancement through the recycling of materials and thermal energy while effectively connecting business sectors such as activated carbon, sodium silicate, silica gel, and clean energy.Furthermore, the Company has been deepening its cooperation with Yihai Kerry Arawana in promoting the sustainable development of rice husk and rice husk ash-based production of sodium silicate and activated carbon. Relevant construction work has already been kick-started in Panjin, Liaoning. This strategic presence build-up in new raw materials such as rice husks bodes well for sharpening the Company's long-term competitiveness.

Potential risks:

Risks in macroeconomic activities; intensified market competition; risks during the implementation of the fund-raising projects; volatility of raw material prices; fluctuations in exchange rates.

Investment strategy:

Yuanli has been deeply engaged in wood-based activated carbon for over 20 years and has established a solid revenue foundation through wood-based activated carbon and silicates. By venturing into new energy materials such as supercapacitor carbon, hard carbon, and silicon-carbon, the Company has been creating a second growth curve. The demand for wood-based activated carbon is driven by the rigid demand in traditional sectors such as food & beverages, and it has been gradually replacing coal-based activated carbon in the environmental protection field, benefiting from the high-growth rate of the environmental activated carbon industry. We are optimistic about the Company's prospects in the field of new energy carbon materials, which may drive revenue and net profit growth. With its scale advantage and green production methods, the Company has been continuously reducing costs and enhancing efficiency, strengthening its leading position. We revise its 2023E/24E/25E EPS estimates to Rmb0.71/0.94/1.25 (vs previously Rmb0.73/0.93/1.24). After 2023, the Company's main businesses will be divided into traditional business (activated carbon, silicates) and new energy materials business (supercapacitor carbon, hard carbon, silicon carbide). It is suitable to use the SOTP valuation framework. 1) As for the traditional business, we forecast ANP to be Rmb250mn for 2023. With the average comps valuation for Jinsanjiang and Xinri Hengli Steel Wire Rope of 16x 2023E PE based on Wind consensus estimates as a reference, we assign 16x 2023E PE to its traditional business to derive a target market cap of Rmb4bn. 2) As for the new energy materials business (supercapacitor carbon, hard carbon, silicon-carbon, etc), although it is in the early stage of industrialization, the trend is clear. We adopt a price-to-sales ratio valuation method. With the comps valuation for companies such as Putailai, Zhongke Electric, and XFH Technology as a reference, their average PS (TTM) ratios since 2019 are 9x, 7x, and 6x, respectively. In 2021, when the penetration rate of NEVs rapidly increased, their average PS (TTM) ratios were 13x, 11x, and 9x, respectively.Considering the Company's technological advantages in areas such as hard carbon, silicon-carbon, and supercapacitor carbon, we estimate that the Company's revenue from the new energy materials business will reach Rmb617mn in 2025. We cautiously assign 8x 2025E PS, resulting in a market cap of Rmb4.94bn for this segment for 2025. We assume a discount rate of 8.2% (WACC of 8.2%), corresponding to a market cap of Rmb4.22bn for 2023. Taken together, we raise the Company's target market cap for 2023 to Rmb8.2bn and raise the target price for 2023 to Rmb23 (vs previously Rmb22). We reiterate the "BUY" rating.