2023 and 1Q24 results miss our expectations

Shandong Pharmaceutical Glass announced its 2023 and 1Q24 results. In 2023, revenue rose 19% YoY to Rmb5bn, and attributable net profit grew 25% YoY to Rmb776mn. In 4Q23, revenue rose 9.2% YoY to Rmb1.3bn and net profit grew 31% YoY to Rmb162mn. In 1Q24, revenue rose 2.5% YoY to Rmb1.27bn, and attributable net profit grew 33% YoY to Rmb221mn, missing our expectations due to early provisioning for expenses such as major bonuses.

Revenue growing rapidly; product mix improving further in 2023. Sales value of core products molded bottles and brown bottles rose by both 29% YoY to Rmb2.26bn and Rmb1.12bn in 2023. Sales volume of molded bottles in neutral borosilicate glass reached 1.4bn units in 2023 (vs. only 800mn units in 2022). In addition, sales value of ampoules, tube bottles, rubber stoppers, and aluminum caps rose 24%, 18%, 13%, and - 3% to Rmb73mn, Rmb200mn, Rmb260mn, and Rmb56mn in 2023, respectively.

Gross margin rising steadily: In 2023, blended gross margin rose 1.2ppt YoY to 28% due to falling sodium carbonate prices. Gross margin of molded bottles fell 0.6ppt to 39%, while gross margin of brown bottles expanded 3ppt to 24%, helping gross profit grow 24% YoY in 2023.

Rising expense ratio: Selling, G&A, and R&D expenses rose 33%, 30%, and -1% YoY in 2023, respectively. Consequently, selling, G&A and R&D expense ratios expanded 0.4ppt, 0.4ppt and -0.5ppt YoY in 2023, respectively. In 4Q23, selling and G&A expense ratios rose 1ppt and 2.2ppt YoY.

Excellent cash flow: In 2023, The firm's net operating cash flow rose by Rmb796mn YoY to Rmb1.05bn, and its cash from sales-to-revenue ratio rose 5.7ppt YoY to 95%.

Solid financials: Net cash on hand and wealth management products combined stood at Rmb2.7bn at end-2023. The firm declared a dividend of Rmb0.4/sh, implying a dividend payout ratio of 34%.

Revenue dragged by declined trade: In 1Q24, revenue rose only 2.5% YoY. We believe the business for molded bottles in neutral borosilicate glass continued to grow rapidly, while molded and brown bottle businesses combined maintained double-digit growth. However, trade revenue declined, whereas other categories such as tube bottles and ampoules remained largely stable.

Rapid recovery in gross margin: In 1Q24, gross margin rose 6.9ppt YoY to 31% (+3ppt QoQ), driving gross profit up 34% YoY (+8% QoQ).

Expenses rose on provisioning for incentive scheme: In 1Q24, selling and G&A expense ratios rose 0.3ppt and 1.3ppt YoY, mainly due to provisioning for annual incentive expenses in 1Q24.

Net margin rose to a high level. In 1Q24, net margin rose 4ppt YoY to 17.4%.

Trends to watch

Upside in valuation; accelerating improvements in business climate of molded bottles in neutral borosilicate glass: We expect sales volume and prices of molded bottles in neutral borosilicate glass to continue accelerating driven by centralized procurement. This, coupled with falling raw material prices, leads us to estimate that profit CAGR over 2023-2025 may reach 26%. The pharmaceutical packaging material industry in both China and overseas has solid demand. Many companies in the industry (e.g., Schott AG and West Pharma) have expensive valuations. We believe valuations of Shandong Pharmaceutical Glass still have upside potential thanks to strong market demand and its rapid profit growth.

Financials and valuation

We leave our 2024 profit forecast unchanged at Rmb1.02bn and introduce our 2025 forecast of Rmb1.23bn. The stock is trading at 20x and 17x 2024e and 2025e P/E. We maintain OUTPERFORM rating. Considering a valuation rollover from 2023 to 2024, we raise our target price 6% to Rmb37.2, implying 24x and 20x 2024e and 2025e P/E, offering 20% upside.

Risks

Slower-than-expected ramp-up of molded bottles in neutral borosilicate glass; intensifying competition; sharper-than-expected fluctuations in raw material prices.