ORIENTAL YUHONG WATERPROOF(002271)：NON-REAL ESTATE BUSINESS TO DRIVE MEDIUMAND LONG-TERM GROWTH

　　What's new
　　We recently spoke with the management team of Oriental Yuhong Waterproof （Yuhong）。
　　Comments
　　The concentration ratio of the waterproof material industry will likely increase rapidly, thanks to the exit of less competitive companies and demand for high-quality, customized products.
　　There has been an industry-wide earnings decline since 2H21 due to falling demand, credit risk exposure in the real estate industry, and rising raw material prices. Small- and medium-sized enterprises faced sharper earnings decline and pressure on flexibility, which we attribute to: 1） A lack of capability to stock up on raw materials or produce raw materials on their own; 2） reliance on customers with high leverages and poor liquidity, that are unable to pay their debt; and 3） weak risk control. Other companies will likely gain market share after the exit of loss-making firms.
　　Sizable non-real estate markets will become the main source of demand in the waterproof material industry, in our view. We expect demand for high-quality, customized products to increase. In addition, leading companies need to add distribution channels and improve services in order to meet demand from customers in different industries and geographical markets. Leading players with well-built product portfolios, more diverse distribution channels, and extensive experience in engineering and services are more likely to gain market share, in our view.
　　Yuhong gains an advantage in distribution channels by offering incentives to small business customers and supporting partners. The company has more than 20 years' experience in providing services to small business customers. Yuhong has rapidly increased its presence in non-real estate markets thanks to its top-down and bottom-up distribution mechanisms.
　　The top-down distribution mechanism: Yuhong has taken an integrated approach to reforming its organizational structure to increase its geographical presence and to better assign resources, rights, and responsibilities. The firm has allocated business resources to departments at the provincial and municipal level, and increased distribution channels for non-real estate products in lower-tier cities, so as to increase its market share in non-real estate markets. In addition, the company has also invested in factories and held minority equity in other firms' projects, so as to obtain orders in regional markets.
　　The bottom-up distribution mechanism: Yuhong, by leveraging its construction training system and extensive engineering experience, is able to offer support to its partners in terms of market exploitation, construction training, project guidance, and supply chain finance. Its support to partners may enhance the retention and stickiness of the partner team, and improve its advantage in distribution channels, in our view. We estimate that revenue contribution of integrated projects reached 45% in 2021. Non-real estate businesses will likely become a main growth engine for revenue from small business customers.
　　2Q22 earnings to remain solid thanks to effective cost control and price hikes. Asphalt prices have risen since May 2022. Specifically, building asphalt prices increased 13% QoQ in 2Q22. However, we believe the cost pressure will remain manageable, as asphalt costs account for less than 25% of the firm’s overall costs, and prices of chemical raw materials have remained flat （prices of some chemicals have even declined）。 Meanwhile, Yuhong purchases asphalt from overseas suppliers, and it also produces some raw materials （e.g., non-woven fabrics, functional films, and vinyl acetate ethylene [VAE] emulsions）。[1] In addition, we expect the firm to initiate the price hikes it announced in March[2] for newly-signed orders. We believe its 2Q22 earnings will remain solid amid effective cost control and price hikes.
　　Financials and valuation
　　We maintain our 2022 and 2023 EPS forecasts of Rmb2.13 and Rmb2.70. The stock is trading at 21.7x 2022e and 17.1x 2023e P/E. We maintain an OUTPERFORM rating and our target price of Rmb62.5. Our TP implies 29.3x 2022e and 23.1x 2023e P/E, offering 35.3% upside.
　　Risks
　　Growth of non-real estate businesses disappoints; raw material prices increase more sharply than expected.
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   【免责声明】本文仅代表第三方观点，不代表和讯网立场。投资者据此操作，风险请自担。