Yu Diamond: Diamond faucet with undervalued stock price

Summary 2012 underperformance analysis: The company's 2012 results fell significantly below our previous expectations of 4 cents per share. There are three main reasons behind this underperformance. First, the micro-powder business did not deliver the expected growth and contributed little to profits, falling short of our earlier forecast of 1 dime. Since acquiring the micronized joint venture in Q4 2011, the company has made progress in relocating, registering, and rationalizing import/export tariffs, which has laid a solid foundation for the recovery of the micronized business in 2013. Second, the slowdown in fixed asset investment growth led to lower prices for low-grade single-crystal products, negatively impacting the company’s performance. Third, equity incentive expenses of RMB 10.67 million affected earnings by nearly 2 cents. These costs will be amortized at RMB 7.34 million in 2013 and RMB 2.66 million in 2014, with the impact gradually diminishing over time. Looking ahead to 2013, the company's core businesses show potential for improvement. First, the single-crystal segment: While industry supply is increasing, the top three suppliers continue to dominate the mid-to-high-end market. The price of low-grade materials has hit a bottom, and with the commissioning of the 1.02 billion carat project, production is expected to rise by 30% in 2013. Second, the micronized powder business: After a year of restructuring, the company has placed greater emphasis on this area, aiming to position it as a new growth driver. We remain optimistic about its future, especially given its applications in precision grinding and functional uses based on thermal and optical properties. Third, the wire saw business: Despite the ongoing challenges in the photovoltaic sector, the company has paused the development of this segment. However, with signs of recovery in the PV industry and supportive policies, the company plans to adjust its strategy accordingly. In recent months, the broader market has rebounded, but the company’s stock has only risen 20% from its lows. As a functional new material company with strong earnings volatility, the stock remains in a relatively undervalued range. Investment recommendation: We expect EPS for 2012, 2013, and 2014 to be RMB 0.25, RMB 0.33, and RMB 0.42 respectively. With the current stock price reflecting a 17x P/E ratio for 2013, we maintain a "Strong Buy" rating. Risk warning: A sharper-than-expected decline in macroeconomic growth could pose a risk to the company’s performance.