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CSCI-Stock Connect-Three-Circle Group (300408 CH)：A leader in advanced ceramics - 20180207

A leader in advanced ceramics

Three-Circle Group takes lead in the production and sales of ceramic-based optical communications components, alumina ceramic substrates and ceramic matrices used in resistors.

Ceramic chassis. Three-Circle Group is well placed to benefit from the would-be introduction of ceramic housing by China’s incumbent “big three” smartphone makers, Huawei, Oppo and Vivo, as different from its domestic peers, Three-Circle Group is self-sufficient in ceramic powder, able to produce 1mn pieces of ceramic chassis per month.

Multilayer ceramic capacitors (MLCC). A dearth of MLCC supply estimated to last for at least a year and a half compounded by a surge in the prices of palladium, a key ingredient of MLCC, together with increasing demand emanating from such burgeoning areas as EV and auto electronics and the growing use of passive components for smartphones, would spur and sustain a MLCC price upturn, in our view, providing tailwinds for Three-Circle Group, whose MLCC division earned around RMB100mn in 2016, accounting for 4% of its full-year revenue.

Ceramic-based optical communications components. With gross margin exceeding 50%, the company’s fiber optic ceramic ferrules and sleeves business claimed a market share of more than 80% by year-end 2017, up from the previous 50%, thanks mainly to a practice of price-cutting since the beginning of 2016 on the back of its self-sufficiency in ceramic powder and economies of scale. Looking ahead, as 5G deployment is imminent which will dial up demand for optical communications components, the company may as well make a U-turn in its pricing strategy, in our view.

Electroceramic packaging. Three-Circle Group’s semiconductor devices unit (including electroceramic packaging) recorded a 2016 operating revenue of RMB600mn, a far cry compared to about RMB14.1bn for that of Kyocera. Hence, there is plenty of scope for Three-Circle Group to keep up with its arch rival.

Earnings forecast. We predict Three-Circle Group to have net profit attributable to the parent of RMB1.078bn/1.551bn/2.111bn for 2017-2019, corresponding to EPS of RMB0.62/0.90/1.22 and 35x/24x/18x PER. Our six-month target price of RMB29.60 is based on a 33x PER for 2018. Upgrade to Buy.