The scarce domestic leader in self-developed Ethernet switching chips was covered for the first time, giving a “buy” rating company as a scarce domestic self-developed Ethernet switching chip enterprise. It has been deeply involved in Ethernet switching chips for nearly 20 years. In 2020, it ranked fourth in the domestic commercial Ethernet switching chip market share, second only to the world's leading commercial Ethernet switches, Broadcom, Meiman, and Realtek. The company now has switching chips with a switching capacity of 100Gbps to 2.4Tbps and a port rate of 100M-400G, covering Ethernet switching products from the access layer to the core layer. Self-developed Ethernet switching chips have entered the supply chain of many mainstream domestic network equipment vendors, and its market influence continues to increase. Based on self-developed Ethernet switching chips, the company continues to enrich its product matrix and expand its business to switching chip modules, switches and customized solutions. As self-developed chips enter the mass production stage one after another, it is expected to recoup the high investment in early R&D and gradually reverse losses. We expect the company's revenue for 2024-2026 to be 1.362, 1.737, and 2.205 billion yuan, respectively. The current closing price corresponds to PS of 11.46 times, 8.98 times, and 7.08 times, covering it for the first time, giving it a “buy” rating.

Focus on R&D investment and continue to enrich the product matrix. The company that has sent samples of 25.6T high-speed switching chips attaches great importance to R&D investment. By the end of 2022, Arctic series chips had invested 0.158 billion yuan in R&D expenses. At the end of 2023, the company already has 16 core high-performance architecture technology, and has successfully applied 4 core technology and 8 core technology in 12.8 Tbps and 25.6 Tbps Arctic chip products. Arctic series chips have been sent to customers and can support up to 800G rate ports. Higher switching capacity chips are already being developed, and route switching integrated network chip research and development projects are progressing steadily, and it is expected that the product line depth will continue to be broadened.

The switching chip industry has high barriers, and the company's products have been recognized by leading customers. Domestic replacement large space switching chips have large platform characteristics. After screening key factors such as chip performance matching, agreements, and industry technical standards, customers tend to choose 1-2 chip solutions for large-scale deployment. The application life cycle of switching chips is 8-10 years. After selecting the switching chip, customers will carry out long-term continuous development around the switching chip and configure a dedicated software and hardware R&D team, engineer team, etc. The chip replacement solution will bring high manpower and R&D costs. Customers are less receptive to new entrants to the chip, and have a high customer stickiness and industry threshold. The company is rooted in the domestic market, and its products have been recognized by leading customers such as Xinhua 3, Ruijie Network, ZTE and Maipu Technology, and is expected to benefit deeply under the wave of localization.

Risk warning: the amount of switching chips falls short of expectations, network demand falls short of expectations, upstream supply chain risks.