The rise in unit prices of key products boosted Tongfeng’s revenue growth against market headwinds. With the gradual capacity release of projects funded by IPO proceeds in 2H22 and the widening of the supply-demand gap for ultra-thin polypropylene (PP) films, we expect its revenue to remain solid growth in 2023 with a better performance in 2H23 compared with 1H23. We have witnessed significant growth in profit margins driven by a rising gross profit margin (GPM) and the increase in foreign exchange gains. In 2023, with the continuous adjustment of product structure and the widening of supply-demand gap, we expect broader growth upside of PP film prices, which may lead to a higher comprehensive GPM and stronger profitability. Once again, as a manufacturer with solid technology reserves, leading base film capacity and an integrated value chain, Tongfeng's future growth will be mainly driven by the capacity release of thin film capacitors and higher PP film prices boosted by the widening supply-demand gap. We reiterate "BUY".

Operating overview:

Tongfeng released its 2022 annual report, posting operating revenue of Rmb1.04bn, up 4.04% YoY, and attributable net profit (ANP) of Rmb74mn, up 45.41% YoY, equivalent to EPS of Rmb0.13. It posted ex-one-off net profit of Rmb65mn, up 43.58% YoY. In 4Q22, the Company achieved operating revenue of Rmb258mn, up 0.33% YoY, and ANP of Rmb21mn, up 21.22% YoY, with ex-one-off net profit at Rmb19mn, up 42.87% YoY. At the same time, the Company disclosed its 2023 target sales revenue of Rmb1.15bn, up 10.53% YoY.

The rise of unit prices of key products boosted revenue growth.

The shipment of Tongfeng’s major products posted a significant decline.Among them, the shipment of electronic-grade film materials reached about 14kt, down 19.5% YoY, with that of capacitors at 46.4627mn units, down 17.2% YoY. However, the Company's operating revenue increased slightly, mainly due to: 1) imbalanced supply-demand dynamics for ultra-thin PP films, which led to a significant rise in material prices. Over the past two years, ultra-thin PP film prices skyrocketed driven by the demand for new energy, wind and photovoltaic power demand and the limited capacity expansion due to production facility constraints. Tongfeng expanded the proportion of ultra-thin PP film production to meet the market demand, which will usually cause a decline in production and sales, leading to a higher electronics-grade film material price per unit. According to our calculations, the average unit price reached about Rmb34.5k per tonne in 2022, up 44.52% YoY; 2) structural adjustment, which led to a significant increase in the unit price of capacitors. Over the past two years, the Company has been continuously restructuring capacitors by expanding the share of capacitors that used in new energy, which has by far achieved significant results. According to our calculations, the Company’s average selling price (ASP) of capacitors rose to Rmb8.8 per unit, up 23.91% YoY. Looking ahead, with the gradual capacity release of projects funded by IPO proceeds and the widening of supply-demand gap for ultra-thin PP films, we expect operating revenue to　maintain robust growth, and 2H23 growth may outrun that of 1H23.

Significantly improved profitability driven by a high GPM and a rise in foreign exchange gains.

In 2022, the Company's administrative expenses increased significantly (up 39.15% YoY) due to the increase in sales scale and the higher salaries of the management, as well as a sharp rise in impairment losses on assets caused by declining inventory prices and contract compliance costs. Under such circumstances, the enhancement of profitability mainly driven by the increase in GPM and foreign exchange gains: 1) As mentioned above, the sharp rise in electronic-grade film price per unit driven by the imbalanced supply-demand dynamics for ultra-thin PP films, and the significant rise in capacitor price per unit due to structural adjustment, pushed the blended GPM to spike; 2) Rising USD exchange rates resulted in an increase in foreign exchange gains.

Looking ahead to 2023, with the continuous restructuring of capacitors and the vaster growth upside for PP film prices due to the widening of the supply-demand gap, we expect that the Company's blended GPM and profitability to grow further.

Potential risks: Macroeconomic fluctuations affection operation; intensified competition weighing on profitability; price fluctuations of raw materials producing a drag on profitability; lower-than-expected PP composite copper foil penetration rate; inventory impairment.

Investment recommendation: We once again reiterate that Tongfeng’s future growth momentum mainly comes from the release of production capacity and the widening of the supply-demand gap: 1) The Company has expanded or newly built multiple film capacitor projects after the shareholding restructuring in 2020. These projects have entered or are about to enter the harvesting period at this point. 2) Currently, the supply and demand for ultra-thin PP films is in a tight balance. With the continuous promotion of the industrialization, the supply and demand gap is likely to further widen going forward. As an ultra-thin PP film manufacturer with leading production capacity, Tongfeng will be the first to benefit. We forecast the Company's 2023E-2024E ANP to be Rmb119mn/166mn and add 2025E ANP forecast of Rmb192mn, up 60.8%/39.4%/15.6% YoY, respectively, equivalent to EPS of Rmb0.21/0.29/0.34. We maintain our 2023E target market cap of Rmb5bn, corresponding to a target price of Rmb8.9, and reiterate "BUY".