Innovation New Material is a leading domestic aluminum processor that is well-poised to benefit from its rapidly expanding capacity and significantly improving processing fees in the future. We expect its 2023E/24E/25E attributable net profit (ANP) to be Rmb1,273mn/1,431mn/1,608mn, implying EPS forecasts of Rmb0.32/0.36/0.40. We assign 20x 2023E PE, corresponding to a target price of about Rmb6, and initiate coverage with a "BUY" rating.

The leading domestic aluminum processor improves operating results steadily.

Innovation New Material ("the Company") is a technology-based enterprise focusing on the research, development, production, and processing of aluminum alloys and products, providing comprehensive solutions in the field of aluminum alloy processing. The Company is currently one of the largest aluminum material producers in China, with an output of 4.22mt in 2022. Its operating revenue increased from Rmb38.12bn in 2019 to Rmb69.32 in 2022, an increase of 81.8%, while its ANP increased from Rmb0.53bn in 2019 to Rmb1.09bn 2022, implying a remarkable increase of 105.1%. In 1Q23, the Company's ANP declined by 31.3%, which was mostly due to macroeconomic factors and downstream customers.

The domestic aluminum processing industry will likely continue to grow.

According to Antaike, the consumption of domestic aluminum alloy bar will likely increase from 27.52mt in 2021 to 30.44mt in 2025, implying a 2.6% CAGR; while that of domestic aluminum extrusion is likely to rise from 20.97mt to 23.30mt, with a CAGR of 2.7%. Among these aluminum material areas, industrial aluminum extrusion will likely see the most significant growth. Driven by the rapid development of the new energy vehicle (NEV) industry and the trend of light weighting, the total demand for passenger vehicle aluminum extrusion in China may increase from 705kt in 2021 to 1,998kt in 2025, with a CAGR of 29.7%, indicating an obvious growth headroom. Moreover, the use of recycled and green aluminum will become long-term trends.

The production capacity has the advantages of large scale and various locations.

In 2022, the Company's annual output was 4.22mt, including 3.12mt of bars, 502.7kt of strips and foils, 99.8kt of profiles, 497.4kt of aluminum bars and cables and 36.42mn pieces of structural components. The Company continues to vigorously increase the aluminum processing business, in addition to supporting financing projects, there are a number of projects under construction with capacity over 1mt. After the commissioning of the projects, the capacity of the Company's aluminum bars (including recycled aluminum), strip and foil, and profiles are likely to rise by 82.4%, 83.0%, and 118.9% respectively. Originated from Binzhou Shandong, the Company has built production bases in Qingdao Shandong, Suzhou Jiangsu, Wenshan Yunnan, Honghe Yunnan, and Tongliao Inner Mongolia, and the diversified layout helps the Company promote sales and enter into new markets.

The processing fees continue to rise thanks to product structure optimization.

Product structure upgrading is a necessary step for aluminum processing companies to achieve high returns. The Company's bar products enter into areas including consumer electronics, automobiles, new energy, etc. Its strip and foil products expand to areas including high-end decoration, home appliances and furniture, food packaging and so on, while the profile products adopt differentiated strategies and focus on consumer electronics and automobiles. Consequently, its overall processing fee continued to rise. In 2019-21, the average processing fees of the Company's bar, strip and foil, and profile products increased by 18.9%, 15.5%, and 84.7% respectively. With the continuous improvement of product structure, the Company's profitability will likely to increase.

The first-class customer resources could help with the Company's expansion into the automobile sector.

The Company has established stable relationships with a number of leading companies in the downstream aluminum processing and terminal industries. It has become a key part of Apple's aluminum supply chain, and has entered its core supplier list for three consecutive years since 2018. In the process of cooperation with Apple, the Company's custom design, quality control and supply chain management capabilities have been continuously improved. The abundant reserve in technology and experience in supply chain management are likely to boost the Company's presence buildup and development in the automotive field.

The Company boasts the advantage of green materials.

In response to Weiqiao's capacity transferring, the Company raised capital to build a 1.2mt/a recycled aluminum project in Yunnan. Moreover, benefiting from Yunnan's abundant hydropower resources, the Company's footprint in Yunnan will help increase its share of green aluminum alloy products and reduce its energy costs. In addition, based on the Company's announcement, it plans to increase its recycled aluminum capacity to 2.05mt/a by 2025. The Company is in the leading position in terms of recycled aluminum upgrading.The construction of recycled aluminum projects will help the Company meet its raw material demand and enhance its profit margin in the future.

Potential risks: The capacity expansion not up to expectations; more-than-expected industry competition; fluctuations in energy and raw material prices; higher-than-expected accounts payable turnover ratio; capacity relocation by the Company's suppliers

Investment strategy: Innovation New Material is a leading domestic aluminum processor with aluminum alloy bar capacity ranking first both at home and abroad, and it is well-poised to benefit from its rapidly expanding capacity and significantly improving processing fees in the future. We expect the Company's 2023E/24E/25E ANP to be Rmb1,273mn/1,431mn/1,608mn, implying EPS forecasts of Rmb0.32/0.36/0.40. Considering the average valuation level of 19.7x 2023E PE (Wind consensus estimates) for comparable companies including Furong Technology (603327.SH), Lizhong Group (300428.SZ), Haomei New Materials (002988.SZ) and Yongmaotai Automotive (605208.SH), we assign 20x 2023E PE, corresponding to a target price of about Rmb6, and initiate coverage with a "BUY" rating.