GCL Technology reported 1Q24 revenue of Rmb5.47bn (-50.1% YoY) and net profit to the attributable shareholders of Rmb33mn (-99.2% YoY), in line with our expectation but below market expectation.

Average cost of granular silicon was higher in 1Q24 due to lower-than-expectation production volume and wafer sector recorded net loss. According to the company, production volume of granular silicon in 1Q24 was 65494MT and shipment was 65189MT (including internal sales of 3300MT). ASP (VAT inclusive) of granular silicon in 1Q24 was Rmb55/kg. We estimate that revenue of granular silicon was Rmb3.012bn. For the wafer sector, we estimate revenue realized Rmb2.358bn and shipment was 10.7GW. Other revenue including sales of scrap materials and silane gas was roughly Rmb100mn. In 1Q24, net profit to the attributable shareholders was Rmb33mn, and total profit was Rmb47mn, among which wafer sector generated loss of Rmb50mn and impairment loss on inventories was Rmb100mn. We estimate that silane gas generated profit of Rmb64mn and granular silicon contributed profit of Rmb133mn. Average cost in 1Q24 was roughly Rmb46.5/kg. Average cost of granular silicon was higher in 1Q24 mainly due to lower-than-expectation production volume. From January to February, Xuzhou and Baotou bases were affected by extreme weather such as sandstorms and freezing rain, and therefore output was lower. According to management, monthly production volume has returned to normal level since March and average cost was Rmb45/kg. As capacity of 120,000MT 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 Rmb39/kg in 2024. Given that the electricity rate cut in western China has been gradually abolished and 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. 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. The company characterizes the powder content by introducing measurement of turbidity, the lower the turbidity, the better the quality. We estimate that demand of N-type polysilicon in 2024 could reach 1000-1200 thousand MT. Considering its current mixing ratio rate, the theoretical demand of granular silicon in 2024 could reach 250-360 thousand MT. Full-caliber granular silicon production of the company in 2024 would reach 360 thousand MT and we believe the company could sell all its production considering the price difference. By end 1Q24, the proportion of granular silicon products with turbidity below 100 NTU reached 75%, 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. In early April, the company signed a long-term procurement agreement with LONGI Green Energy Technology, regarding sales of total 425 thousand MT granular silicon to LONGI by end of 2026, which could be treated as an endorsement for the quality of granular silicon.

Oversupply of polysilicon sector. Based on our channel checks, we estimate that nominal capacity of polysilicon in China by 2024 could reach 3110 thousand MT. Despite that some projects may be delayed due to current extremely low price, we estimate that supply will reach 2200 thousand MT in 2024 (+43.7% YoY), which could satisfy roughly 833GW 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. According to Silicon China, latest price of N-type polysilicon was Rmb43/kg and price of N-type granular silicon was Rmb37.5/kg. Such prices were below the cash costs of most companies in the industry and the market expected that companies would arrange overhaul in May. We believe that large-scale production cuts and shutdowns in the industry are signs that polysilicon prices have bottomed out. However, the top four companies insisted on their capacity expansion, with a nominal capacity of 1935 thousand MT by end of 2024. We therefore believe the bottom of the current cycle will remain for a long time until 2025. Only companies with cost advantages and sufficient cash flow reserves will survive.

Maintain BUY Rating. Because price of polysilicon has fallen dramatically since April, we revised our ASP (VAT inclusive) assumptions of granular silicon from Rmb55/58/60/kg to Rmb49.5/54/60/kg in 24-26E in a cautious manner. Considering the improved cost of granular silicon and the net loss of wafer sector, we cut our EPS forecast from Rmb0.06 to Rmb0.01 (-85.1% YoY) in 24E, from Rmb0.12 to Rmb0.09 (+555.2% YoY) in 25E, and revise EPS forecast from Rmb0.15 to Rmb0.16 (+76.3% 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 37% 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.