XIANHE CO LTD(603733)：2Q22 PROFIT MARGIN IMPROVES QOQ;FORESTPULP-PAPER INTEGRATION UNDERWAY

What's new

    We recently spoke with management of Xianhe Co., Ltd. (Xianhe) about the firm's recent business operations and its medium- and long-term development outlook.

    Comments

    Industry leader to maintain stable results despite COVID-19 resurgence; 2Q22 profit margin to improve QoQ. Xianhe's shipments remained solid in April and May 2022. The firm continued to gain market share despite COVID-19 resurgence. It's sales volume grew 7% YoY in 1H20 and 18% YoY in 2020 amid the initial COVID-19 outbreak. This was in line with our judgement that the firm might be more affected by inflation than by stagnation. However, as the company typically postpones its pulp costs on a quarterly basis and generally uses pulp purchased during the previous quarter, its pulp profit started to come under pressure in April 2022. Considering that the firm completed the first round of price hikes in April 2022, we think its profit margin will likely improve QoQ in 2Q22. Looking ahead, given strong coal demand in the summer and disruptions to pulp supply, we think the firm's energy and raw materials will remain under pressure until end-3Q22. If domestic demand recovers and pulp prices stay high, we think the firm will likely start a new round of price hikes. However, assuming that overseas demand declines or overseas broad-leaved tree wood pulp capacity increases, we think pulp prices may drop from the current highs at end-2022. We expect the firm's valuation and earnings to both recover at that time.

    Continues to improve product portfolios and adjust production capacity in line with changes in consumer demand. Thanks to robust exports and sales of medical-grade paper, the firm expects its 300,000t/yr high-margin food packaging cardboard capacity at its Changshan production base to come online in 3Q22. In 2022, we expect the sales volume of this product to rise at least 15% YoY. We think companies such as Xianhe have secured solid leadership in the domestic specialty thin paper market. However, the mid-range to high-end thick paper market is mainly dominated by imported products such as liquid packaging board. We believe the firm will likely produce food-grade thin paper and thick paper after its new project in Changshan comes online. We expect the firm to provide integrated packaging solutions for downstream large catering clients and replace imported thick paper materials by leveraging its high-quality products and cost advantages.

    Has long-term competitive advantages in products and technologies; accelerated deployment in forest-pulp-paper integration to improve cost advantages. We think there is a good opportunity for domestic specialty paper to enter overseas markets given that raw material prices and energy costs in Europe and marine transportation costs from Europe to Chinese ports are rising. Overseas demand for some types of specialty paper (e.g., food-grade packing materials, thin printing materials, and heat transfer printing materials) has notably increased. Given local selling prices, we estimate that European specialty paper leaders such as Ahlstrom, UPM, and Stora Enso increased their selling prices by more than 20% YoY in 1Q22, and their selling prices were more than 20% higher than domestic selling prices. We expect Chinese specialty paper suppliers to enter overseas markets. Currently, Xianhe is supplying products to new foreign clients. We think the firm will obtain long-term orders thanks to its products featuring high and stable quality and its advanced technologies. In the medium and long term, the firm will grow into an international paper enterprise, in our view. Taking into account European paper prices and the transportation costs from Europe to Chinese ports, we think Xianhe enjoys clear price advantages and will see further profit growth in mid-range and high-end specialty paper. We are optimistic that domestic leaders will gradually replace overseas high-end specialty paper in the medium term. In addition, Xianhe's forest-pulp-paper integration projects in Guangxi and Hubei are proceeding smoothly. We expect these projects to improve the firm's cost advantages and increase its average profit margin.

    Financials and valuation

    We maintain our 2022 and 2023 EPS forecasts at Rmb1.45 and Rm2.06. The stock is trading at 15x 2022e and 11x 2023e P/E. We maintain an OUTPERFORM rating and our target price of Rmb30. Our TP implies 21x 2022e and 15x 2023e P/E, offering 37% upside.

    Risks

    Higher-than-expected increase in pulp prices and energy cost; disappointing downstream demand; disappointing capacity expansion