1H23 results in line with our expectations

Asia Cuanon Technology (Shanghai) announced its 1H23 results: Revenue rose 5% YoY to Rmb1.49bn and attributable net profit grew 21% YoY to Rmb39.21mn. In 2Q23, revenue rose 7.6% YoY to Rmb1bn and attributable net profit fell 22% YoY to Rmb55.17mn, in line with our expectations.

Demand was under pressure; revenue recovered slowly. In 1H23, revenue of the coatings segment rose 3.8% YoY to Rmb1.04bn (-8% YoY in 1Q23 and +11% YoY in 2Q23), with total sales volume of coatings increasing 10% YoY to 320,000t (+4% YoY in 1Q23 and +13% YoY in 2Q23). Among other segments, revenue from thermal insulation fell 3.5% YoY to Rmb293mn (+27% YoY in 1Q23 and -14% YoY in 2Q23), and revenue from waterproofing rose 75% YoY to Rmb112mn. In addition, revenue contribution from direct sales rose 3.9ppt YoY to 20.5%.

Prices of coatings were stable and gross margin recovered markedly. Thanks to stable prices of the firm's engineering coatings (ASP down only 3.6% YoY in 1H23, smaller than the industry decline), gross margin of the coatings segment in 1H23 rose 6ppt YoY to 41%. Gross margin of the thermal insulation segment fell 1.8ppt YoY to 17.6%, and gross margin of the waterproofing segment fell 4.7ppt to 4.8%. The firm's overall gross margin in 1H23 rose 1.6ppt YoY to 34% (+3ppt YoY to 33.4% in 2Q23).

Expenses were reduced. The firm's expenses were reduced in 1H23 thanks to efficiency improvement and lower headcount. Selling and R&D expenses in 1H23 decreased 19% and 17% YoY, and G&A expenses increased 3.5% YoY. Expense ratio in 2Q23 fell 2.6ppt YoY.

A leading profit margin after excluding credit impairment. The firm's net margin in 2Q23 fell 2.1ppt YoY to 5.5% due to more than Rmb70mn of provisions for impairment of accounts receivable. Excluding the impact of credit impairment, the firm's operating margin in 2Q23 may have reached 14.5%, leading its peers.

Cash flow improved substantially. Operating cash flow in 1H23 turned positive to an inflow of Rmb68.59mn, with the ratio of cash received to revenue staying high at 99%. Accounts receivable increased Rmb130mn HoH and accounts payable increased Rmb223mn HoH.

Debt ratio was relatively high. Liability-to-asset ratio was stable at 75% and net gearing ratio was 103%.

Trends to watch

Marked improvement in operating quality; demand recovery to boost earnings upside. We note that the firm's efforts to achieve reasonable growth in volume and significant improvement in quality and transform its revenue structure (reducing the proportion of thermal insulation and increasing the proportion of coatings) have boosted its gross margin and cash flow. The firm's gross margin is now among the highest in the industry. Looking ahead, if demand recovers, we believe the firm's earnings will have large upside potential thanks to cost reduction and efficiency improvement.

Financials and valuation

Considering slow recovery in demand and credit impairment provision, we cut our 2023 and 2024 net profit forecasts 26% and 18% to Rmb188mn and Rmb300mn. The stock is trading at 22x 2023e and 14x 2024e P/E. Considering increased policy support, we only lower our target price 8% to Rmb12, implying 27x 2023e and 17x 2024e P/E and offering 23% upside.

Risks

Disappointing recovery in demand; lower-than-expected revenue contribution from distribution channels; intensifying competition.