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An emerging national champion; raising TP

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    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 10years. 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.

Like it never ends;

    At the right time

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    "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 topdownpush 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 10years. 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%).

Is it the way how we came to this world?

    In the right place

Something not finished,
Something always need to be done
Something we want to concor

    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 still dominated 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.2player in China's low-voltage inverter and No.3inthe general servo market by 2020. By 2025, Inovance is highly likely to lead bothmarkets, based on our estimates.

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