Zhong Ke San Huan Alert:9M16preliminary beat DBe,FY17forecast trimmed

9M16 results beat DBe but missed market consensusZKSH announced its 9M16 results after market close on 27 Oct 2016. Itrecorded revenue of RMB2,549m, down 1% YoY and a NPAT of RMB231m, up25% YoY in 9M16. The results beat FY16DBe, achieving 84% FY16 DBe butmissed market consensus, achieving only 69% Bloomberg consensus.

    Stable 3Q16 operations; we expect the same for 4Q16The magnet price and PrNd price kept almost flat in 3Q16. ZKSH’s flat revenueand slightly lifted COGS in 3Q16 (up 3% QoQ) well followed what happened inspot market in 3Q16. 4Q is supposed to be peak season for magnets due todemand from electrical products and we expect 4Q16 operations to remainstable as ZKSH has increased its sales exposure to foreign automobile makers.

    New joint-venture obtained business licenseZKSH announced that its joint venture with Hitachi obtained its businesslicense on 3 Sep. We believe that the new joint venture will focus on high-endproducts with high margins. Thus, the new JV should help to improve ZKSH’soverall gross margin going forward. Margin impact from the new JV should belimited due to small volume of shipments in early stage.

    Hold reiterated on stretching valuationWe factored in the profitability improvement with all other assumptionsunchanged. As such 2017/18 NPATs are upgraded 8%/4%. Our DCF-derived TP(with an unchanged WACC of 8.1% and terminal growth at 2%) is upgraded toRMB14.7 from RMB14.2. Our new TP implies ~10% downside potential. Holdreiterated. Currently, ZKSH is trading at RMB16.4, implying 66x/40xFY16/FY17E EPS. Major risk: significant policy in China EV policy.