汇川技术(300124)

An emerging national champion; raising TP

According to an ancient Chinese proverb, to win a battle, it requires the right time,right place and right people. In the battle for market share in China’s industrialautomation (IA) sector, we believe all these three factors align with Inovance.In terms of timing, the Chinese government’s strong push for manufacturingupgrades and promotion of high-end manufacturing should help to sustain robustIA demand in the next 10 years. On top of it, local players who focus on hardwareequipment will accelerate their market share expansion, given the government’sintention to promote local champions. Along with management’s impressivemarket insights and distinct “vertical-based” strategy, we believe Inovance is wellplaced to top the inverter and servo markets in China by 2025. With sustainablelong-term growth and an industry-leading position, we believe the stock’s currentvaluation premium is warranted. We raise target price to Rmb34.3.

At the right time

“Made in China 2025” was first unveiled in May 2015, at a time when China’smanufacturing industry and IA market were struggling. Thanks to a strong topdown push from the government, China’s IA market started to recover in 2H16,with the recovery positively surprising in recent quarters. We view this round ofIA recovery as structural instead of cyclical, and hence we believe it is highly likelyto persist in the next 10 years. Apart from government support, manufacturerswho are facing poor quality, low efficiency, and labor shortages have also startedto voluntarily automate their production facilities. This trend has now spreadinto traditional verticals such as textile machinery, machine tools and metallurgy,signaling that current China’s automation upgrades have become broad-based.We expect China’s overall IA demand to post a 10% CAGR in 2017-20, whilethe general servo and low-voltage inverter markets, Inovance’s two focusedsegments, to register a CAGR of c.20% and 10%, respectively, over 2016-20 (vs.+6% and -5% over 2011-16). Over 2021-25, we expect China’s general servo andlow-voltage inverter markets to witness a CAGR of 10% and 5%, respectively (vs.China’s overall IA market: 5%).

In the right place

China’s current manufacturing upgrades still largely center on hardwareequipment, which has been Inovance’s strong suit. In addition, the government’spromotion of localization has been intensifying, which would accelerate localplayers to gain market share. Currently, 65% of China’s IA market is stillominated by foreign players. In some of Inovance’s focused markets, the ratiocan be as high as c.90%. Leveraging its deeper understanding of local customersand improving the price-to-performance ratio of its products, Inovance hassuccessfully grown into a local leader capable of challenging MNCs’ positionsin certain areas. Its low-voltage inverter and general servo already ranked No.3and No.5, respectively, in China. With accelerating import substitution, we expectInovance to become the No.2 player in China’s low-voltage inverter and No.3 inthe general servo market by 2020. By 2025, Inovance is highly likely to lead bothmarkets, based on our estimates.

With the right people

I novance’s success, in our view, is probably more driven by its management thanits technology and/or products. A strong evidence to support this is the localcompetitors of Inovance, in our view. Several started out with similar businessat a similar time with similar technology but have fallen significantly behindInovance after a decade of operations. Driven by management’s aggressivebut practical manner, Inovance has successfully penetrated into multiple areasincluding inverter, servo and NEV, and quickly built up a leading position.Inovance recently launched a distinctive “vertical-based” penetration strategythat is completely different from its local and foreign competitors. Instead ofpushing existing products to customers, the core strategy is to focus on deeplyunderstanding customers’ trued needs and developing customized products.Through this practice, Inovance can not only penetrate but also quickly dominatedownstream verticals. Air compressor is a good case in point. By coming up withcustomized drive solutions (inverter+controller), Inovance has rapidly occupiedmore than 2/3 market share of this particular vertical. The most recent successfulcases are textile machinery and metallurgy, and we expect many other verticalsto follow.

The same thing can be said about NEV

Inovance has been a proven leader in the NEV bus drive market and we expectsuch success to be repeated in the logistics and passenger NEV. Growth forlogistics NEV drive this year has been ahead of market expectation and we expectsuch to continue to surprise the market on the upside. By 2020, we expectInovance to take a 60% share in China’s logistics NEV drive market, bringingin Rmb1bn in revenue (or 36% of the total NEV segment) and surpassing NEVbus revenue. Meanwhile, its passenger NEV drive business is also progressingwell, having secured 5-6 tier-2 automakers and is likely to secure another 1-2tier-1 automaker(s) by year-end. Over the longer term, we believe having a strongelectronics platform (through its IA business) will give Inovance significant costadvantage over its peers (e.g. lower sourcing pricing for IGBT due to largervolume), which will further facilitate its market share expansion.

Fine-tuning earnings and raising target price; maintaining Buy

We trim our earnings estimates by 3-4% for 2017-19E, mainly reflecting ourmore conservative assumptions on margins due to the company’s heavy R&Dinvestment in the passenger NEV drive business. Still, our 2018-19E earnings are5-10% higher than consensus forecasts. We see upside potential in our currentestimates as we have not factored in meaningful robots sales in coming years.As we turn more bullish on Inovance’s long-term growth prospects, we lift ourtarget price by 14% to Rmb34.3, after raising our long-term growth assumptionsand rolling forward our valuation timeframe to 2018. We maintain Buy.