1H23 results missed our forecast and market expectations Shanying International announced its 1H23 results: Revenue declined 18% YoY to Rmb13.7bn, and attributable net profit fell 312% YoY to - Rmb271mn. In 2Q23, attributable net profit turned positive QoQ at Rmb70mn. The firm’s 1H23 results missed our forecast and market expectations mainly due to weak domestic demand and the impact of zero tariff on imported paper.

Comments:

Paper prices continued to drop due to weak domestic demand and higher-than-expected paper imports. In 1H23, paper imports surged　due to the zero tariff on imported paper and weakening overseas demand.

According to the General Administration of Customs, imports of recycled containerboard and corrugated board rose 63% and 49% YoY to 1.73mnt and 1.74mnt in 1H23. Weaker-than-expected domestic demand led to continued declines in paper prices. Prices of containerboard and corrugated board fell 24% and 21% YoY, hitting their three-year lows, according to Resource Information Systems Inc (RISI).

Sales volume recovered QoQ in 2Q23. The firm’s run rate recovered　and capacity utilization rate increased QoQ in 2Q23. Sales volume of raw paper rose 24% YoY (or 45% QoQ) to 1.75mnt in 2Q23, according to the firm’s announcement.

Turned profitable in 2Q23; gross margin rose 1.8ppt QoQ. The firm’s　gross margin and net margin increased 1.8ppt and 6.3ppt to 9% and 1% QoQ in 2Q23 as the firm’s run rate recovered and prices of core raw materials (including domestic old corrugated cardboard [OCC] and coal) declined.

Cash flow recovered significantly; capex still high. Net operating cash　flow recovered to Rmb772mn in 1H23, primarily due to a sharp decline in inventories and increased shipments of raw paper. Capex was Rmb1.26bn, and liability-to-asset ratio was 72%. We suggest watching potential changes in the liability-to-asset ratio amid capacity expansion.

Trends to watch Earnings began to improve in 2Q23; recent price hikes to boost　confidence. In 1H23, paper prices hit historical lows amid weak domestic demand and the impact of imported paper. As a result, the industry suffered losses for five consecutive quarters. However, we believe pessimistic expectations have been fully priced in and see limited downside room in share prices after the industry experienced multiple stress tests in 1H23. Recently, some industry leaders have announced price hikes of Rmb30-50/t. If end-market demand recovers in 2H23, we expect containerboard and corrugated board sectors, which are highly correlated with retail sales of consumer goods, to be the first to start restocking and price hikes. However, the recovery of overall earnings and share prices may be mild. In addition, coal prices and domestic OCC prices are declining rapidly. We expect sector leaders to regain cost advantages and their earnings in 2Q23 have shown signs of recovery.

Capacity expansion well on track. After the 0.77mnt of capacity in

Zhejiang came on-stream in 1H23, Shanying International now has 7.50mnt of raw paper production capacity. It plans to put its 0.35mnt and 0.3mnt industrial packaging paper projects in Zhejiang and Jilin into operation within 2023, In addition, the firm plans to build another 1.8mnt of packaging paper capacity in Suzhou, a city in Anhui province. If the abovementioned projects start operations as expected, we believe the firm’s capacity will exceed 10mnt and market share may increase from 10% to 20%. The firm has more than 1.5mnt of recycled pulp capacity, making itself largely self-sufficient in long fibers. Meanwhile, it is making steady progress in expanding its high-quality fiber production capacity. We expect this to contribute incremental earnings in the medium term given the scarcity of high-quality raw materials in the industry.

Financials and valuation

Considering weaker-than-expected paper prices, we lower our price and profit margin assumptions for the papermaking sector. We cut our 2023 net profit forecasts 84% to Rmb197mn and introduce 2024e net profit forecast of 1.1bn, implying 0.7x 2023e and 0.7x 2024e P/B. We maintain OUTPERFORM and our target price of Rmb3, as we roll over valuation to 2024 and the papermaking sector is recovering. Our target price implies 1x 2023e and 0.9x 2024e P/B, offering 35% upside.

Risks

Downstream demand disappoints; sharper-than-expected price hikes of domestic OCC or coal; more new capacity than expected.