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The whirlwind of the Yellow River: ensuring the rapid growth of polycrystalline composites business
**Investment Recommendation:**
The company is projected to report earnings per share (EPS) of 0.43 yuan, 0.53 yuan, and 0.64 yuan for the years 2013, 2014, and 2015, respectively, with corresponding dynamic P/E ratios of 14X, 12X, and 10X. This suggests that the stock is currently undervalued relative to its earnings growth potential. The polycrystalline composite business is expected to be the main driver of profit growth, offering significant upside potential at the current valuation level. Therefore, we maintain our "Recommended" rating.
**Key Highlights:**
The polycrystalline composite sheet segment is anticipated to outperform expectations in 2013. The company maintains a strong position in the domestic super-hard materials market, with consistent order flow and smooth development of new products. In traditional businesses, the slowdown in economic growth has had limited impact on the diamond monocrystalline sector, and the company’s expansion continues steadily. Growth in 2013 will primarily come from the fundraising project, particularly the polycrystalline composite sheet and pre-alloyed powder segments, with the former showing stronger-than-expected performance.
Polycrystalline composite sheets represent one of the most valuable links in the diamond industry chain. The upstream diamond single crystal production is expanding in an orderly manner, ensuring sufficient raw material supply. China's single crystal diamond output grew rapidly between 2001 and 2011, with a compound annual growth rate of 21.3%. Major manufacturers are planning further expansion, expecting supply to grow by 10%-20% over the next three years. This stable supply ensures pricing stability for raw materials.
The demand side presents a huge opportunity, especially with the growing natural gas sector. China faces a rising natural gas demand gap, which is expected to increase from 40 billion cubic meters in 2012 to 75 billion by 2015, and potentially reach 90 billion by 2020. Harsh drilling conditions in China's gas fields are driving the replacement of cemented carbide bits with PDC bits. It is estimated that by 2015, the market for polycrystalline composite sheets used in oil and natural gas exploration in China could reach 890 million yuan.
High entry barriers and large import substitution potential also support the investment case. Technical and certification barriers limit competition, with nearly 70% of PCD composites for petroleum drilling dominated by U.S. firms such as Synthetic Diamond, DI, and Element Six. Domestic companies hold only about 3% of the market, indicating substantial room for growth.
The polycrystalline composite business is growing rapidly, while the traditional single crystal segment continues to expand steadily. With increased production capacity and more high-end orders, we expect polycrystalline composites to contribute approximately 0.07 yuan to EPS in 2013, while traditional single crystal products will add around 0.03 yuan to EPS.
**Risks to Consider:**
1. A decline in the diamond boom could affect demand.
2. Slower progress in the investment project than expected may delay revenue growth.
Overall, the company is well-positioned to capitalize on the growing demand for polycrystalline composite sheets, supported by strong fundamentals and a favorable industry outlook.