1H22 results in line with our forecast

    　　Huayou Cobalt announced its 1H22 results: Revenue rose 117% YoY to Rmb31.02bn, and attributable net profit increased 54% YoY to Rmb2.26bn. Its 2Q22 revenue was Rmb17.81bn (+126% YoY and +35% QoQ), and attributable net profit was Rmb1.05bn (+29% YoY and -13% QoQ) , within the preannounced range of Rmb2.2-2.6bn.

    　　Trends to watch

    　　Impairment loss pressure will likely to fall in the future. The firm made an Rmb537mn provision for inventory impairment losses due to price fluctuations of cobalt and nickel products. As it takes time for the firm to purchase raw materials and manufacture the products, falling prices lead to impairment losses for raw materials and inventories. We believe the impairment loss pressure will likely ease for two reasons. First, we think the price of cobalt copper is unlikely to fall significantly in 2H22. Given the boost from recent purchasing and reserve expectations, easing price inversions globally, cobalt salt smelting’s profit recovery, as well as the coming peak season for downstream alternative fuel vehicle (AFV) consumption, we expect the cobalt price to return to Rmb350,000-400,000/t and the copper price to remain at US$7,000-8000/t. Second, the profit of nickel products may start to ramp up in 3Q22. In 1H22, PT. Huayue Nickel Cobalt, a subsidiary of Huayou, generated net profit of Rmb1.35bn, with 20,000 tonnes of nickel output (our estimates). As Huayue sells its nickel products to Huayou, the profit will not be recognized until the precursors made of nickel are sold. Furthermore, the firm expects the Huake project to reach design capacity soon. We thus expect the earnings of the nickel business to grow in 2H22.

    　　Expansion of nickel, lithium, and LiB materials continues; the firm’s growth potential remains robust. First, the firm’s nickel business is progressing smoothly, with strong future growth potential. Its capital pressure is gradually easing. As the firm’s Huayue and Huake projects reached design capacity in 1H22, we expect the firm to have 40,000t/yr attributable capacity in hand in 2022. The total planned capacity for nickel maybe 585,000 tonnes, suggesting strong growth potential. Second, the firm is building an integrated presence in the lithium value chain from the mine-end to lithium salt smelting. This could be the main earnings contributor next year. We estimate that the lithium business of Huayou Cobalt could generate about Rmb2bn net profit in 2023. Third, the expansion of the lithium-ion battery (LiB) materials business is accelerating. The firm aims for production capacity of 1mnt/yr of precursors and 500,000t/yr of cathode materials in 2025. By leveraging this, it plans to build solid relationships with clients including Tesla, LG, Ronbay Technology, and Easpring to secure first-mover advantage.

    　　Ternary battery products are of higher value for money as the impact of COVID-19 eases, cobalt and nickel prices decline, and battery technology upgrades. First, as the resurgence of COVID-19 in China is gradually contained, LiB downstream demand is undergoing a sound recovery. Second, the second reform of laterite nickel ore led to the supply ramp-up of nickel and cobalt, lowering the raw material prices of ternary battery products. Compared with lithium iron phosphate batteries, ternary batteries’ value-for-money is recovering. As a result, the valuation of ternary-related names may pick up. Third, battery technology iteration may solve ternary materials’ dilemma between efficiency and safety. We expect ternary materials’ higher value-for-money to boost sector valuation recovery.

    　　Financials and valuation

    　　We largely maintain our 2022 earnings forecast. As the lithium business will likely start to contribute earnings next year, we raise our 2023 net profit forecast by 20.2% to Rmb9.06bn. The stock is trading at 22.8x 2022e and 14.4x 2023e P/E. We maintain OUTPERFORM. Due to the dividend distribution and share capital increase in June, the firm’s total equity base increased from 1.221bn to 1.588bn shares. Excluding this, we raise our TP by 16.6% to Rmb110.00 (30.7x 2022e and 19.4x 2023e P/E), offering 34.9% upside.

    　　Risks

    　　Demand from downstream AFV industry lower than we expected; disappointing progress of projects in Indonesia; metal prices drop sharply.

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