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Guoxuan High-Tech:Uncertainties on future transition but neg

Aggressive expansion target but uncertainty looms over NCM; maintaining Hold

Aggressive expanding separator and mild improving pipe; initiating with Buy

We visited GCL-Poly premises in Xuzhou, noting progress in the firm’s diamond wiresawretooling efforts. We maintain our EPS forecasts at Rmb0.12 in 17E ( 7.9 YoY), revised upEPS forecast from Rmb0.12 to Rmb0.13 in 18E ( 8.4% YoY), and from Rmb0.13 to Rmb0.15in 19E ( 9.7% YoY). With relatively high wafer prices at present vs 1H17 and ongoing costcontrols by the firm, we revise up our target price from HK$1.04 to HK$1.82. With 22%upside, we upgrade to BUY recommendation.

    As the third-largest Chinese battery player, Guoxuan positions itself to more thandouble its capacity from 7.5GWh in 2017to c.18GWh by end-2020, and targetsto triple its market share to c.18% in three years. However, we believe there isstill uncertainty regarding Guoxuan's endeavors in NCM (lithium nickel cobaltmanganese oxide) batteries (c.22% of 2017shipment) after the disappointmentsin the past 12months. We set our target multiple at 15.4x 2019E P/E, in line withthe industry average, and revise our target price to RMB15.6while maintainingHold.

    Separators: expanding capacity three-fold to catch up with strong demand CZMZ is expanding separator capacity three-fold to catch up with strong demand from EV battery supply chain at a CAGR of 30%. This accounts for c.25% of gross profit in 2017, rising to 41% by 2019E and underpins our positive outlook on the company. Separately, it has a consistently strong plastic pipe business (c.40% of gross profit) which will benefit from coal-to-gas switch projects and may increase volume at a CAGR of c.15% in the next three years. The BOPA business (c.35% of gross profit) will likely see profitability decline but the strong separator and pipe operations should boost its bottom line at 21%/13% YoY in FY17/18E. We initiate coverage with a Buy.

    Retooling goes smoothly. GCL-Poly’s polysilicon wafer capacity currently stands at 20GW,vs LONGi Green Energy Technology’s (601012:CH - BUY) capacity of 12GW ofmonocrystalline silicon wafer. By end-June, just 30% of GCL-Poly’s capacity had switchedto diamond wiresaw tech, although as of now, the percentage stands at c.70%. We believeby end-2017, the completion rate will top 80%. The technology reduces cutting time by afactor of c.3-5x and reduces silicon material wastage, with a cost saving of c.US$0.1/ps.

    Targets to triple its Chinese battery market share to 18% in 2020

    Separators: expanding capacity three-fold to catch up with strong demand

    We expect non-silicon cost will decline by c.20% after the company completes the switchto diamond wiresaws, which we anticipate will happen by early 2018.

    On top of the existing 7.5GWh capacity in 2017(including 5.5GWh for LFP (lithiumiron phosphate) and 2.0GWh for NCM), Guoxuan is adding 2GWh LFP capacityand c.4GWh NCM capacity in 2018. Total capacity is expected to reach c.18GWhby end-2020at a 3-year CAGR of 33%, but revised down from 20-25GWhpreviously. The company's mid-term strategic target is to triple market share from6% in 2017to c.18% in 2020, to become a formidable competitor against thecurrent industry leader CATL.

    We believe that the separator industry will continue to face a supply shortage over the next few years due to strong demand and a lack of quality producers, able to provide large scale volume. CZMZ has decided to increase its capacity three-fold by 2019, increasing its global market share from 4% in 2016 to 6% in 2019. Although pricing for industrial separators could continue to decline, CZMZ is likely to maintain high margins above 50% in the next three years, with: 1) cost cuts from technology improvements and economies of scale; and 2) more value-add through coating.

    Polysilicon: larger market space, lower cost. Currently, GCL-Poly’s polysilicon capacity isc.70,000t, representing c.17% of global capacity. Assuming that global annually installedsolar capacity will be 70GW for the following three years, we anticipate polysilicondemand of 350,000t per annum. With c.90% of wafer manufacturers located in China, webelieve annual demand for polysilicon in China will reach 315,000t. However, China’sannual polysilicon capacity is only c.200,000t. The monthly polysilicon import was morethan 10,000t (17,628t in September). The current import dependence rate is more than60%. If the government adopts a stricter stance on polysilicon imports from Korea, whichaccounts for c.40% of China’s total polysilicon imports, the potential market for domesticpolysilicon is very large. Furthermore, with GCL-Poly putting 40,000t of new polysiliconcapacity into operation in Xinjiang Province in 2018, we expect substantial cost savingsdue to low power costs in the region.

    Meaningful progress on NCM batteries in 2H18remains to be seen

    Pipe business: a major beneficiary of ‘coal-to-gas switch’ projects

    Policy motivated. On 8 November, the National Development & Reform Commission(NDRC) released Guidelines on Reforming Pricing Mechanisms, calling for solar grid parityby end-2020, to be achieved by lowering solar tariffs. We see firms with low productioncosts, such as GCL-Poly, as positioned to benefit from the more challenging marketconditions for higher-cost peers.

    The company is upgrading its NCM lines in Hefei and Qingdao for all NCM622production starting in 2H18, and expects its NCM battery shipment to reach1.3GWh in 2018, or 92% YoY. Guoxuan supplied it batteries to 45k units of NEVin 2017, and aims to reach 100k units in 2018with orders by domestic brandsincluding BAIC, Geely, Zotye, Chery, SAIC, and JAC. However, it remains to beseen whether Guoxuan, a previously LFP-focused battery manufacturer (c.78% of2017shipment), can have a meaningful presence in NCM batteries.

    The traditional plastic pipe business grew at 25% YoY in 2016, when ‘coal-to-gas switch’ projects were being constructed in Northern China to deal with the smog issue. CZMZ may continue to be one of the major beneficiaries of ‘coal-to-gas switch’ projects in the next three years due to: 1) geographic advantage within the c.500km transportation radius of plastic pipes; 2) capability of providing a full set of pipe products including connectors, which require higher manufacturing technology; and 3) strong client relationships.

    Upgrade to BUY. We maintain our EPS forecast at Rmb0.12 in 17E ( 7.9 YoY), revised upEPS forecast from Rmb0.12 to Rmb0.13 in 18E ( 8.4% YoY), and from 0.13 to Rmb0.15 in19E ( 9.7% YoY). We revise up our target price from HK$1.04 to HK$1.82, representing 13x17E PE and 1.3x 17E PB, or 12x 18E PE and 1.2x 18E PB. With 22% upside, we upgradefrom Outperform to BUY rating.

    Cutting target price to RMB15.6; concerns factored in; risks

    High visibility growth with a CAGR of 17% 2017-18E; initiating with Buy

    We believe the c.40% share price decline in the past three months has reflectedinvestors' concerns such as a) ASP/margin pressure in the medium term and b)the uncertainty regarding its transition to NCM batteries. Factoring the 19% YoYASP decline and shipment disappointment in 2017, we cut our 2018/2019NPATforecasts by -27%/-50%. We set the target multiple at 15.4x 2019E P/E, in linewith the industry average, and revise our TP accordingly. Risks: quicker/slowerthan-expected ASP cut or cost drop.

    The BOPA business has outperformed since 2016, the result of an unbalanced market demand/supply after the exit of a major player. However, we believe that super high profitability will revert back to the historical long-term average level of c.15% when more supply is added. Despite this, the strong expanding separator and improving pipe business should boost the bottom line at CZMZ with a CAGR of 17% in 2017-18E and keep ROEs c.20%. We set our target price at RMB26, based on 25x FY18E EPS, which is the average of lithium battery components industry, implying 24% upside potential. Major risks: significant EV subsidy policy changes; capacity expansion being slower than expected (cf p.5).

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