Why did third-quarter results disappoint Citi?

  • In the third quarter of 2026, Envicool’s revenue rose 33% year on year to 1.93 billion yuan, accelerating from 17% growth in the first half. But net profit attributable to shareholders rose just 0.3% to 184 million yuan, well below Citi’s and VA consensus expectations.
  • Citi said this was the company’s fifth consecutive earnings miss and cut its 2026–2027 earnings forecasts by 18%–24%.

Why might growth in liquid cooling not translate into high margins?

  • The main difference between Citi and market expectations concerns margins in the emerging liquid-cooling business. The bank believes barriers to entry for liquid cooling in AI infrastructure are relatively low, new entrants can become general contractors, and competition will intensify.
  • The liquid-cooling business is service-centric, and Citi believes it is less scalable than areas such as copper-clad laminates, PCBs and optical modules. The company’s domestic gross margin has fallen from about 34.5% in 2015 to 23.8% in 2025.
  • The domestic business accounts for about 85% of total sales and faces intense price competition. Meanwhile, the transfer of the headquarters campus to fixed assets has increased depreciation, staffing new capacity in advance has pushed up administrative expenses, and share options have also added costs.

A sharp fourth-quarter increase is expected, but how strong is its underlying quality?

  • Citi expects fourth-quarter 2026 revenue to rise 48% year on year to 3.02 billion yuan, and net profit to grow 95% to 239 million yuan. But the strong profit growth largely reflects a low base in the same period of 2025, when domestic gross margin was under pressure and share option expenses were incurred.
  • The report said inventory at the end of the third quarter had risen to 2.51 billion yuan from 980 million yuan at the end of 2025, while contract liabilities over the same period increased from 231 million yuan to 665 million yuan. Citi believes the company has prepared more inventory for installation and is waiting for customer acceptance before recognizing revenue; these balance-sheet figures alone do not show the pressure on fourth-quarter gross margin.

How does the earnings expectations gap affect valuation?

  • Citi’s latest earnings forecasts for 2026, 2027 and 2028 are respectively 35%, 54% and 62% below VA consensus, and the bank maintains its sell rating.
  • Citi cut its target price from 49 yuan to 37 yuan, applying a forecast 2027 price-to-earnings multiple of about 57 times. The bank lowered the valuation premium from 3 standard deviations above the historical mean to 0.5 standard deviations, citing consecutive earnings misses and a decline in industry valuations among its reasons.