Description

Warom Technology is a $1.2bn market cap company trading in the Shanghai exchange.  Company is the market leader in the niche domestic explosion-proof electrical equipment industry.  Size of the industry is ~10bn RMB domestically and RMB20bn outside of China.  The industry is primarily focused on equipment for use in coal mines where gas is present or in environments where explosive dusts might be present.  Oil, gas and chemical industries are the major downstream industries although due to new safety standards being implemented in China, new industries are adopting the products. Driven by policy support and technological advances, the company has stepped up efforts to promote the use of its products in other industries such as baijiu and nuclear power. 

Warom Is the largest player in the industry with ~20% market share (revenue is ~3-4x of the next competitor).  We like business due to some structural competitive advantages.  Historically, safety was not valued in China and most contracts were awarded to companies who bid for the lowest price – resulting in mkt share grab based on cost and not quality.  Since 2018, based on top down government tightening of standards, production safety was prioritized – project managers at an individual level could be held liable for any production safety missteps – as such, industry participants started focusing on given out contracts based on quality vs. price.  As a result of these changes, company’s growth has accelerated significantly – between 2016-2018, revenue went from 1.2bn to 1.6bn rmb; since 2018, revenue went from 1.6bn to estimated 3.9bn in 2022. 

A second driver of growth is international expansion.  Domestic revenue represents ~90% of total revenues and it’s estimated that Warom only has a 3% market share of overseas industry.  Given safety standards, barriers of entry are high given product certifications needed and supplier qualification standards. Over the last 10 years, Warom has obtained more than 400 qualified product certifications for it explosion-proof products from international organizations.  Given its history of good product quality and service, it has won major contracts from Shell, Total and BP (in addition to the large domestic customers which include PetroChina, Sinoped and CNOOC).  From a products perspective, quality already rivals those of the firm’s European peers (i.e. R.Stahl). The biggest advantage comes from the cost side -   given the specificity of many of these products and enhanced safety standards, it is difficult to achieve automated production and assemply of explosion-proof electrical equipment. As such, prosecution and assemply requires a large number of manual workers. It’s estimated that labor costs account for 47% of R.Stah’ls revenue vs. 37% of Warom’s. 

Given the large structural barriers to entry + cost advantage, company has a very stable financial profile. Margins for the overall company is ~55% but looking at lighting products which is the largest category, margins are in the 60% range.  Company generates ROIC of ~30% with all of the FCF going down to net profits resulting in net margins of 9-10%.  Given the high ROIC and FCF profile of company, we expect company to growth at 20% FCF range. Stock currently trades at 14x 2023 PE.

Catalyst

Domestic growth driven by new regulatory standards + overseas expansion