SOBUTE NEW MATERIALS(603916)：RISING PORTION OF LOW-MARGIN PRODUCTS DRAGS GROSS MARGIN IN 2Q22;MEDIUM-TERM MOMENTUM INTACT

　　1H22 results missing our expectation
　　Sobute New Materials (Sobute) announced its 1H22 results: Revenue fell 14.6% YoY to Rmb1.75bn, and attributable net profit dropped 24.0% YoY to Rmb164mn. In 2Q22, revenue declined 19.0% YoY to Rmb1.03bn, and attributable net profit decreased 39.1% YoY to Rmb84mn. The firm’s 1H22 results missed our expectations mainly due to lower-than-expected gross margin (GM) driven by cost hikes and rising portion of low-margin products in 2Q22.
　　Notable impact of COVID-19 resurgence on sales volume. Sobute’s sales volume of high-performance water-reducing admixtures (WRA) fell 20.5% YoY to 514,400t in 1H22, and declined 25.1% YoY to 316,400t in 2Q22. We mainly attribute the decrease in the sales volume to weak demand in 1H22 and COVID-19 resurgence in eastern China (where Sobute’s core production bases and markets are located). The COVID-19 pandemic has largely weighed on logistics in eastern China. As a result, the firm’s sales volume of WRA fell faster than nationwide sales volume of cement.
　　GM under pressure from falling ASP, cost hikes and rising portion of low-GM product in 2Q22. In 2Q22, Sobute’s GM fell notably, down 5.3ppt QoQ to 33.9%. We mainly attribute the falling GM to: 1) Declining ASP: The firm hiked the price of its WRA in 4Q21, which remained largely stable in 1Q21 but fell 4.5% QoQ in 2Q22. 2) Cost pressure: In 2Q22, the price of epoxy ethane (the firm’s main raw material) rose QoQ. Coupled with a higher amortized cost amid falling production due to COVID-19 resurgence, this pushed up the firm’s costs and put its GM under pressure. 3) Rising portion of low-GM products: In 2Q22, the ASP of functional materials dropped 8.4% QoQ mainly driven by rising shipments of lower-GM rapid setting admixtures, thus bringing down the firm’s GM, in our view.
　　Operating cash flow improved; accounts receivable turnover days increased. Sobute’s operating cash flow fell Rmb24.55mn YoY to -Rmb156mn in 1H22 and -Rmb115mn in 2Q22 (vs. -Rmb185mn in 2Q21). The firm’s cash-flow-to-revenue ratio increased significantly YoY to 109% in 1H22, mainly due to a YoY decline of 18% in admixture sales. The accounts receivable turnover days rose from 176 days in 1H21 to 268 days in 1H22.
　　Trends to watch
　　Demand likely to recover; functional materials to boost medium-term growth. In 1H22, weakening demand from the real estate industry, coupled with disrupted shipment and logistics in eastern China and high temperatures weighed on the firm’s downstream demand. Looking to September-December, we expect recovery in infrastructure construction to drive a rebound in demand amid peak season, supporting earnings growth in 2H22. In 1H22, Sobute’s revenue from functional materials reached Rmb233mn, accounting for 17% of total admixture revenue (+3.9ppt YoY). Its revenue contribution has been growing in the past five years and doubled compared with 8% in 2017. We expect sales and output of the firm’s functional materials to maintain rapid growth in the medium term, and its high value-added products (e.g., anti-cracking materials, wind power grouting materials and transportation materials) to further expand market, offering an important boost to steady growth in the firm’s earnings.
　　Financials and valuation
　　Considering weaker-than-expected demand, we lower our EPS forecasts 16.7% to Rmb1.25 and 12.3% to Rmb1.66. The stock is trading at 16.0x 2022e and 12.0x 2023e P/E. We maintain an OUTPERFORM rating and cut our TP 12.3% to Rmb25.96 (implying 20.8x 2022e and 15.6x 2023e P/E), with 30% upside.
　　Risks
　　Recovery in demand disappoints; sharper-than-expected epoxy ethane price hikes.
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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。