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Equity Bottom-Up

Leoch International Technology / Equity Bottom-Up

Leoch [842_HK; HK$618 million/US$80 million market cap] reported a decline of only 7% in its overall revenues for the 1HFY2020 ended June which was far more resilient as compared to the overall industry performance during the period. The company’s revenues declined by 7.1% YoY to RMB3,684 mn. &nbsp;Revenue from the total Battery business segment amounted to RMB3,405 mn,&nbsp;a marginal increase of 0.5% from RMB3,390 mn for the corresponding period in 2019. Despite the global recession and weak overseas market demand, the company still achieved solid performance in its Power Solutions business in the first half of 2020. The overall shipment in tons to PRC customers improved by more than 35% but that of the overseas market decreased by 5% as compared to the corresponding period of last year. The volume of shipments increased by more than 15% in total during the period which was contributed by a stable recovery of the Chinese economy. This positive growth in revenue from its core battery business segment, during uncertain times, signifies a strong competitive market position of the company, signaling more robust growth in the near future when conditions come back to normalcy.
Recycled Lead business amounted to RMB278 mn, a decline of 51% from RMB569 mn for the corresponding period in 2019.&nbsp; This decline in revenues for the recycled lead business segment was on account of a reduction in the average SMM lead&nbsp; price in excess of 13%&nbsp; as&nbsp; compared&nbsp; to the average price of 2019 during the first half of FY2020. This resulted in a growth in volumes for the recycled lead business but a decline in revenues for the first half of 2020 for the company. We expect the recycled lead business to make up for the lost ground in the second half of the year to contribute more quantum of revenue to the overall business as the plant has resumed full operations late in the month of May. It effectively operating only for one month in the first six months of FY2020.
The EPS declined by 67% on a YoY basis to RMB2 cents on account of lower revenues from the recycled lead business, an increase in research and development expenses up 49%, a rise in impairment losses on financial assets to RMB12 mn, and a drastic fall in other income and gains. The fall in other income and gains was on account of large gains seen in the last year same period due to gain on selling of a subsidiary which was one-time in nature. The company continues to witness a reduction in finance costs (down 18% YoY) while selling distribution and administration expenses continue to remain flat YoY. We believe the rise in research and development expenditure should generate higher growth and increase margins for the company going forward through product innovation. Once the recycled lead business makes up for the lost business in the second half, along with increased revenues from the battery segment due to further recovery, the overall profitability would return to normal levels.
To capture tremendous opportunities arising from the 5G era and meet growing demands for compelling power solutions for the current and future market needs, Leoch has expanded its manufacturing capacity both locally and overseas, with a new lithium-ion plant in China and two new lead-acid plants in Vietnam in 2019. With all the capacity expansion undertaken in FY2019 along with rising gross profit margins (13% from 11.8% YoY in 1HFY2020) declining finance costs (18% lower YoY) and selling and distribution expenses remaining flat, we believe with all the negatives behind, the company is geared up to deliver on growth and is staring at an Inflection Point in 2020 to make the best of its opportunities. With the issuance of 5G licenses for commercial use by China’s Ministry of Industry and Information Technology (MIIT) in June 2019, we believe revenue from the Reserve Power (especially in the Telecom and Data Center sub-segment – largest contribution to total revenues) would resume its upward growth momentum in 2HFY2020 and beyond.&nbsp;
Maintain PT at HK$1.00; 117% Upside
We maintain a one year PT on Leoch at HK$1.00 per share implying an upside of 117% over the current stock price of HK$0.46. Our price target implies a P/E multiple of 9.6x on our FY2021 EPS estimate of RMB 9 cents and an EV/ EBITDA multiple of 5.5x on our FY2021 EBITDA estimate of RMB515 mn. With all the negatives factored into the stock price along with secular tailwinds provided by the recent 5G network launch, increasing vehicle penetration in China and increasing demand for light electric vehicles, etc., we continue to remain positive on the stock. At the current levels, the stock is trading at extremely attractive multiples of just 4.4x P/E and 4.4x EV/EBITDA based on our FY2021 EPS and EBITDA estimates, respectively.
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&nbsp;Uptick in Gross Profit Margin 
Gross profit slightly increased by 1.5% from RMB470 mn in 1HFY2019 to RMB477 mn for 1HFY2020, mainly due to higher contribution from the battery business of the company resulting in an increase in the overall gross profit margin from 11.8% for 1HFY2019 to 13% for 1HFY2020. Higher gross profit margins were a result of lower production costs for the overall battery business segment.
Motive Power Battery Segment - Stellar Growth of 40%
The Reserve Power batteries sub-segment revenues declined by 6.4% to RMB1,842 mn (1H2019: RMB1,968 mn) and accounted for 50% of total sales during 1HFY2020. The decrease was mainly due to disruptions in shipment for overseas markets in the first quarter followed by weak overseas demand when the pandemic spread all over the world. However, the growth momentum for the Telecom and Data Center business in China continues to recover with good demand traction while the overseas demand remains suppressed resulting in an overall temporary decline in sales during the first half of FY2020.
The SLI battery business sub segment reported 2.5% growth to RMB1,051 mn contributing 29% to the overall revenue of the company. The demand for growth from China was seen to be recovering gradually especially in the aftermarket of Covid-19 disruptions, but was offset by a decrease in demand from other countries resulting in a low single digit overall growth.
The motive power battery sub-segment reported a stellar increase in revenues by 40% to RMB482 mn in the first half of FY2020 as compared to RMB344 mn in the corresponding period last year. The increase was mainly due to high demand from China’s market when economic activities were back on track after initial lockdown.&nbsp;
The company’s revenue decreased by 6% to RMB658 mn in Europe, Middle East and Africa, 4% in China to RMB2,285 mn, 18% in USA to RMB432 mn and 14% in Asia Pacific (excluding China).
For further details please see our attached Earnings Update Report.

Leoch [842_HK; HK$618 million/US$80 million market cap] reported a decline of only 7% in its overall revenues for the 1HFY2020 ended June which was far more resilient as compared to the overall industry performance during the period. The company’s revenues declined by 7.1% YoY to RMB3,684 mn. &nbsp;Revenue from the total Battery business segment amounted to RMB3,405 mn,&nbsp;a marginal increase of 0.5% from RMB3,390 mn for the corresponding period in 2019. Despite the global recession and weak overseas market demand, the company still achieved solid performance in its Power Solutions business in the first half of 2020. The overall shipment in tons to PRC customers improved by more than 35% but that of the overseas market decreased by 5% as compared to the corresponding period of last year. The volume of shipments increased by more than 15% in total during the period which was contributed by a stable recovery of the Chinese economy. This positive growth in revenue from its core battery business segment, during uncertain times, signifies a strong competitive market position of the company, signaling more robust growth in the near future when conditions come back to normalcy.
Recycled Lead business amounted to RMB278 mn, a decline of 51% from RMB569 mn for the corresponding period in 2019.&nbsp; This decline in revenues for the recycled lead business segment was on account of a reduction in the average SMM lead&nbsp; price in excess of 13%&nbsp; as&nbsp; compared&nbsp; to the average price of 2019 during the first half of FY2020. This resulted in a growth in volumes for the recycled lead business but a decline in revenues for the first half of 2020 for the company. We expect the recycled lead business to make up for the lost ground in the second half of the year to contribute more quantum of revenue to the overall business as the plant has resumed full operations late in the month of May. It effectively operating only for one month in the first six months of FY2020.
The EPS declined by 67% on a YoY basis to RMB2 cents on account of lower revenues from the recycled lead business, an increase in research and development expenses up 49%, a rise in impairment losses on financial assets to RMB12 mn, and a drastic fall in other income and gains. The fall in other income and gains was on account of large gains seen in the last year same period due to gain on selling of a subsidiary which was one-time in nature. The company continues to witness a reduction in finance costs (down 18% YoY) while selling distribution and administration expenses continue to remain flat YoY. We believe the rise in research and development expenditure should generate higher growth and increase margins for the company going forward through product innovation. Once the recycled lead business makes up for the lost business in the second half, along with increased revenues from the battery segment due to further recovery, the overall profitability would return to normal levels.
To capture tremendous opportunities arising from the 5G era and meet growing demands for compelling power solutions for the current and future market needs, Leoch has expanded its manufacturing capacity both locally and overseas, with a new lithium-ion plant in China and two new lead-acid plants in Vietnam in 2019. With all the capacity expansion undertaken in FY2019 along with rising gross profit margins (13% from 11.8% YoY in 1HFY2020) declining finance costs (18% lower YoY) and selling and distribution expenses remaining flat, we believe with all the negatives behind, the company is geared up to deliver on growth and is staring at an Inflection Point in 2020 to make the best of its opportunities. With the issuance of 5G licenses for commercial use by China’s Ministry of Industry and Information Technology (MIIT) in June 2019, we believe revenue from the Reserve Power (especially in the Telecom and Data Center sub-segment – largest contribution to total revenues) would resume its upward growth momentum in 2HFY2020 and beyond.&nbsp;
Maintain PT at HK$1.00; 117% Upside
We maintain a one year PT on Leoch at HK$1.00 per share implying an upside of 117% over the current stock price of HK$0.46. Our price target implies a P/E multiple of 9.6x on our FY2021 EPS estimate of RMB 9 cents and an EV/ EBITDA multiple of 5.5x on our FY2021 EBITDA estimate of RMB515 mn. With all the negatives factored into the stock price along with secular tailwinds provided by the recent 5G network launch, increasing vehicle penetration in China and increasing demand for light electric vehicles, etc., we continue to remain positive on the stock. At the current levels, the stock is trading at extremely attractive multiples of just 4.4x P/E and 4.4x EV/EBITDA based on our FY2021 EPS and EBITDA estimates, respectively.

&nbsp;Uptick in Gross Profit Margin 
Gross profit slightly increased by 1.5% from RMB470 mn in 1HFY2019 to RMB477 mn for 1HFY2020, mainly due to higher contribution from the battery business of the company resulting in an increase in the overall gross profit margin from 11.8% for 1HFY2019 to 13% for 1HFY2020. Higher gross profit margins were a result of lower production costs for the overall battery business segment.
Motive Power Battery Segment - Stellar Growth of 40%
The Reserve Power batteries sub-segment revenues declined by 6.4% to RMB1,842 mn (1H2019: RMB1,968 mn) and accounted for 50% of total sales during 1HFY2020. The decrease was mainly due to disruptions in shipment for overseas markets in the first quarter followed by weak overseas demand when the pandemic spread all over the world. However, the growth momentum for the Telecom and Data Center business in China continues to recover with good demand traction while the overseas demand remains suppressed resulting in an overall temporary decline in sales during the first half of FY2020.
The SLI battery business sub segment reported 2.5% growth to RMB1,051 mn contributing 29% to the overall revenue of the company. The demand for growth from China was seen to be recovering gradually especially in the aftermarket of Covid-19 disruptions, but was offset by a decrease in demand from other countries resulting in a low single digit overall growth.
The motive power battery sub-segment reported a stellar increase in revenues by 40% to RMB482 mn in the first half of FY2020 as compared to RMB344 mn in the corresponding period last year. The increase was mainly due to high demand from China’s market when economic activities were back on track after initial lockdown.&nbsp;
The company’s revenue decreased by 6% to RMB658 mn in Europe, Middle East and Africa, 4% in China to RMB2,285 mn, 18% in USA to RMB432 mn and 14% in Asia Pacific (excluding China).
For further details please see our attached Earnings Update Report.

Leoch [842]: 5G Play at 4.4x P/E 4.4x EV/EBITDA - Earnings Update Report