Kstar:Short term headwind on higher opex

Ongoing growth in on-line UPS/EV charging pile segments.

    Kstar reported slightly weaker 1Q17 operating results, due to higher R&Dinvestment in the EV charging pile and inverter businesses. It is upbeat on onlineUPS (double digit)/EV charging (100+% YoY) demand, stimulated by robustdata center set-up/government EV promotion policies. The company views2017 as a back-end-loaded year, with 20-50% YoY revenue growth guidance in2H17 to be driven by 1) 10+kVA on-line UPS strength, 2) strong inverterrevenue growth on the government’s poverty reduction project wins, and 3) apotential EV project win from States Power. We like Kstar’s secular industrygrowth trend and solid balance sheet, and reiterate our Buy rating.

    Weaker 1Q17 operating profit due to higher R&D investment.

    Kstar reported 1Q17 earnings of RMB50mn (+2% YoY, -55% QoQ) on revenue ofRMB4bn (+18% YoY, -31% QoQ). Despite a raw material price hike (the leadprice increased 5+% in 1Q17), GPM of 34.5% was roughly in line with our andconsensus estimates, thanks to a favorable product mix change (on-line UPSoutgrew off-line UPS). However, due to higher sales promotion/R&D input for theinverter and EV charging pile businesses, operating profit of RMB60mn (+12%YoY, -25% QoQ) came in 3% lower than our and Bloomberg consensus forecasts.

    Targeting 20-50% YoY top-line growth in 2H17 on EV/inverter strength.

    Kstar described the recent opex hike as an essential investment under itspersistent market share expansion plan for the EV charging and inverter fields.

    Foreseeing strong EV charging demand, Kstar raised 2017 EV chargingrevenue guidance from 50-80% YoY to 100+% YoY, driven by its persistentnew EV/E-bus charging order wins in Zhejiang, Jiangsu and Gansu provinces.

    For UPS, Kstar also anticipates continuing margin expansion from the current38-40% level, propelled by sequential order wins from data center customers.

    Management states that a recent raw material price correction could help easemarket concern and boost faster UPS profit growth from 2Q17 onward.

    Valuation and risks.

    We trim our 2017 EPS estimate by 10% to factor in higher opex, and lower ourtarget price from RMB27 to RMB24, still based on 30x one-year FW-lookingEPS, or 1.0x PEG, in line with Asian peers of 20-30x P/E, or 1.0x PEG. Risksinclude slower EV adoption and price competition.