GCL Technology reported 2023 revenue of Rmb33.7bn (-6.2% YoY) and net profit to the attributable shareholders of Rmb2.51bn (-84.7% YoY).

Energy cost advantage of granular silicon. Solar material business segment reported revenue of Rmb33.5bn (-6.2% YoY) and GPM of 34.6%, down by 14.1pct compared to GPM of 2022. Sales of polysilicon recorded Rmb17.4bn (-1.3% YoY), accounting for 51.7% of overall revenue. Sales of wafer recorded Rmb11.6bn (-17.1% YoY), accounting for 34.5% of total revenue. Total production of polysilicon reached 232,256MT, including 203,561MT of granular silicon (+346% YoY). Total shipment of polysilicon achieved 226,123MT in 2023, including internal sales of 18,450MT. ASP (VAT exclusive) of granular silicon was Rmb76.8/kg. We estimate the company shipped 178,978MT of granular silicon and its average production cost was Rmb45/kg in 2023. As capacity of 100,000MT at Xinhuan base in Hohhot ramps up and inside material supplies of Fluidized bed reactors become adequate, we estimate its average production cost may achieve within Rmb40/kg in 2024. According to SiliconChina, the electricity rate cut in western China has been gradually abolished. C&I electricity rate in Sichuan increased from Rmb0.3/Kwh to Rmb0.5/Kwh in 2H23. Since the electricity consumption of FBR technology is 66% less than that of improved Siemens method, we believe the company will enjoy more benefits from its lower energy consumption in the future.

Improving quality of granular silicon. By end of 2023, the proportion of products with a total metal impurity content of 5 elements of 1ppbw has maintained at approximately 90%. Currently granular silicon can be used in P-type and N-type wafer production with a mixing ratio of 50-60% and 20-30%, respectively. The major defect of granular silicon now is the powder content attached to its surface formed during the fluidization process, which would decrease downstream N-type monocrystalline daily production yield with a high proportion of granular silicon. It is one main reason of the price difference between granular silicon and N-type dense compound feeding materials in the market. The company characterizes the powder content by introducing measurement of turbidity, the lower the turbidity, the better the quality. By end of 2023, the proportion of granular silicon products with turbidity below 100 NTU reached 70%, and the turbidity is being continuously optimized. As a result, we look forward to granular silicon's better performance on downstream wafer production and a resulting smaller price cut. According to CPIA, market share of granular silicon increased from 7.5% in 2022 to 17.3% in 2023. The company's nominal capacity will reach 500,000MT in 2024 with production bases in Xuzhou, Leshan, Baotou and Hohhot. We expect the company will produce 356,100MT of granular silicon in 2024 and maintain a market share of 16.4% in 2024.

A healthier balance sheet. In 2023, the company ceased to hold any direct equity interest in Xinjiang Goens and withdrew from rod silicon production through a proposed dividend distribution and capital reduction, resulting in a disposal and impairment loss of Rmb3,190mn, including Goodwill of Rmb2,417mn. The suspension of rod silicon production at Xuzhou base resulted in an impairment loss totaling Rmb1932mn in 2022 and 2023. In 2022, the company's effective interest in GNE was changed from 44.44% to 7.44% upon the completion of Distribution in Specie. GNE's principal activities became a separate line of major business and its financial statements were no longer consolidated into that of the company. Through such transactions, the company has improved its asset quality and strengthened its BS. It used to suffer from liquidity issues and Interest-bearing liabilities accumulated to Rmb60.5bn in 2018. By end of 2023, the company had Interest-bearing liabilities of 15.3bn. Net debt/equity ratio was 15.9% and free cash flow was Rmb1.13bn.

Oversupply of polysilicon sector. According to SiliconChina, nominal capacity of polysilicon in China by 2023 reached 2112 thousand MT, and total production was 1468.7 thousand MT. With import volume of 62.7 thousand MT, total supply in 2023 reached 1531.4 thousand MT (+70.0% YoY). In 2024, capacity expansion will continue in the sector and supply will reach 2170 thousand MT (+41.7% YoY), which could satisfy roughly 786GW PV installations. Despite that downstream demand is booming and consensus estimates of global PV installations in 2024 reach 500GW, we believe 2024 will see oversupply of polysilicon sector and the price will remain at a low level. In 1Q24, ASP (VAT inclusive) of N-type dense compound polysilicon was Rmb70/kg.

Maintain BUY Rating. Considering oversupply of polysilicon in 2024, our ASP (VAT inclusive) assumptions of granular silicon are revised down to Rmb55/58/60/kg in 24-26E in a cautious manner. We revise down our EPS forecast from Rmb0.43 to Rmb0.06 (-32.0% YoY) in 24E, and forecast EPS of Rmb0.12 (+84.4% YoY) in 25E and Rmb0.15 (+29.5% YoY) in 26E. Due to oversupply, the asset-intensive polysilicon sector is currently at the bottom of the cycle and we therefore believe PB valuation is more appropriate for the company. Given FBR cost advantages and its improved asset quality, we apply 1.0x 24E PB for the company and derive our target price of HK$1.82. With 42% upside potential, we maintain our buy rating.

Risks: downstream demand below expectation. Quality optimization of granular silicon below expectation. Cost improvement of granular silicon below expectation.