YDC(605555)：SMALL HOME APPLIANCES AND AUTOMOTIVE MOTORS TO CREATE DOUBLE GROWTH DRIVERS

　　Investment positives

    　　We initiate coverage on Ningbo Dechang Electrical Machinery Made Co., Ltd. (YDC) with an OUTPERFORM rating and a target price of Rmb33.84, implying 24.0x 2022e P/E.

    　　Why an OUTPERFORM rating?

    　　A leading vacuum cleaner manufacturer; upbeat on category expansion of small home appliances. YDC has a long-standing collaboration with its major client, Techtronic Industries (TTI), on vacuum cleaners. In 2021, the firm reported revenue of Rmb1.22bn from wet and dry vacuum cleaners and Rmb954mn from vacuum cleaners. These two businesses have generated a steady source of income, contributing 80% of the firm's total revenue in 2021. YDC has stepped up efforts to expand its categories and clients to unleash further growth potential. The firm has become the original equipment manufacturer (OEM) supplier to TTI for garden power tools, and to Helen of Troy (HOT) for hair care appliances. In 2021, revenue from hair care appliances grew 25.3% YoY to Rmb438mn, or 15% of total revenue. Meanwhile, we expect sales of power tools, which have entered mass production in 2022, to grow rapidly going forward.

    　　Ventures into auto components; EPS and EHB motors to see growth, paving the way for further expansion into skateboard chassis. The penetration rate of electric power steering (EPS) continues to rise, boding well for import substitution, in our view. EPS motors are the core precision safety component for automotive steering systems. Among domestic manufacturers, YDC has a first-mover advantage in R&D and manufacturing, in our view. We expect the firm to deepen its cooperation with automotive OEMs. The firm has also expanded into the brake motor market. We expect the automotive motor business may become a new growth driver. Drive-by-wire technology is increasingly central as skateboard chassis becomes more important, and EPS and electro-hydraulic brake (EHB) motors are core components of steer-by-wire and brake-by-wire systems. We expect the accumulation of technology in YDC's EPS and EHB businesses to propel expansion into skateboard chassis featuring drive-by-wire know-how. We estimate the firm's automotive motor business will report revenues of Rmb60mn in 2022 and Rmb300mn in 2023.

    　　Profitability to recover as costs fall for raw materials, ocean freight rates ease and renminbi depreciates. In 2021, high prices for raw materials and ocean freight, and appreciation of renminbi against the US dollar put YDC’s profitability under pressure. We expect profitability may recover with an estimated increase of 2ppt in net profit margin in 2022, amid falling raw material prices and renminbi depreciation.

    　　How do we differ from the market? We expect YDC to expand from small home appliances to power tools. In addition, we also believe the firm enjoys a first-mover advantage in the domestic EPS market, bolstering rapid growth in its EPS business.

    　　Potential catalysts: Profitability recovery better than expected; rising sales of motors for its automotive component business or new categories for its home appliance OEM business.

    　　Financials and valuation

    　　We expect EPS to reach Rmb1.41 in 2022 and Rmb1.89 in 2023, implying a CAGR of 29%. The stock is trading at 18.0x 2022e and 13.4x 2023e P/E. We expect YDC to diversify product categories in its home appliance OEM business, and sales from its automotive component business to continue to rise, further driving recovery in the firm’s profitability. We are upbeat on the firm’s long-term growth potential. We initiate coverage with an OUTPERFORM rating and a target price of Rmb33.84, implying 24.0x 2022e and 18.0x 2023e P/E with 34% upside.

    　　Risks

    　　Tariff hike; overdependence on a few clients; declining demand for consumer durable goods from the US and Europe.