SKSHU PAINT(603737)：DEMAND STEADILY RECOVERS;BUSINESS OPERATIONS IMPROVING

　　2022 results in line; 1Q23 results slightly miss

    　　Skshu Paint announced its 2022 and 1Q23 results: In 2022, revenue fell 1% YoY to Rmb11.3bn and net profit attributable to shareholders was Rmb330mn, in line with market expectations. In 1Q23, revenue rose 21% YoY to Rmb2.05bn, attributable net profit was Rmb26.42mn, and recurring net profit was -Rmb42.86mn, slightly missing market expectations due to lower-than-expected GM and relatively high effective tax rate.

    　　2022 review:

    　　Revenue maintained high growth thanks to customer structure adjustment and rapid growth in home decoration. In 2022, the sales volume of home decoration coatings grew 26% to 420,000t and that of engineering coatings declined 11% YoY to 960,000t. Revenue from home decoration coatings increased 18% YoY to Rmb2.57bn and that from engineering coatings fell 8.5% YoY to Rmb4.27bn (vs. YoY growth of -3% and -14% in 4Q22). Meanwhile, revenue from adhesives and coating materials grew 36% and 7.5% YoY.

    　　GM recovered thanks to falling raw material prices. GM rose 2.9ppt YoY to 28.9% (excluding taxes and surcharges), as the ASP of emulsion and titanium dioxide fell 11% and 12% YoY.

    　　Expense ratios diluted. The expense ratio fell 0.6ppt YoY, with selling and G&A expense ratios down 0.9ppt and 0.2ppt YoY. Financial expense ratio was up 0.7ppt YoY.

    　　Impairment losses dragged profit. The firm made Rmb220mn of provisions for credit impairment losses on risky real estate receivables. We think the risk is manageable if the firm provisions 80% of all receivables that have not been fully provisioned, with only Rmb200-300mn of risk exposure.

    　　Strong cash flow. The ratio of cash received from sales of goods to revenue rose 13ppt YoY to 111% in 2022, driving net operating cash flow up 97% YoY to Rmb956mn.

    　　1Q23 review: Revenue from home decoration coatings, engineering coatings, and coating materials rose 16%, 13%, and 53% YoY, driving the total revenue up 21% YoY. Raw material prices edged down QoQ, driving GM up 0.7ppt QoQ to 29.6% (+3.2ppt YoY). Expense ratio fell 2.6ppt YoY to 30.2%, mainly due to a 2.3ppt YoY decline in the selling expense ratio. Cash flow continued to improve.

    　　In 1Q23, the ratio of cash received from sales of goods to revenue reached 141%, and net operating cash flow fell Rmb165mn YoY, mainly due to a QoQ decline of Rmb1.1bn in payables. The firm’s net debt rose Rmb728mn QoQ and the net gearing ratio grew 27ppt QoQ to 135%.

    　　Trends to watch

    　　Demand recovers; business operations improving. In 2023, we expect policies ensuring the delivery of property projects to boost demand from property completions, which grew 15% YoY over January-March. Meanwhile, we expect that market demand for renovation of existing homes accumulated during the COVID-19 pandemic in the past few years will continue growing, fueling demand for coatings. We expect the firm’s GM and net margin to trend upwards as raw material prices turn negative YoY. The firm’s labor efficiency is improving, which we think should push up GM and net margin, boding well for its business operations.

    　　Financials and valuation

    　　We keep our earnings forecasts unchanged. The stock is trading at 37x 2023e and 24x 2024e P/E. We maintain OUTPERFORM and our target price at Rmb150, implying 54x 2023e and 35x 2024e P/E, offering 46% upside.

    　　Risks

    　　Demand recovery disappoints; competition intensifies.