Investment positives

We initiate coverage on Shanghai Tianyang Hot Melt Adhesives Co Ltd (Shanghai Tianyang) with an OUTPERFORM rating and a target price of Rmb12.80, implying 18x 2023e P/E. The company is a leading producer of thermoplastic and polymeric adhesive materials in China. We think it has gained solid competitive advantages in R&D strength, product mix and customer resources. We believe Shanghai Tianyang will start growing rapidly driven by organic development and M&A in the future.

Why an OUTPERFORM rating?

Increasing application scenarios drive sustained industry growth.

Adhesives: Size of the global adhesive industry expanded from US$24.6bn in 2011 to US$63.2bn in 2020, implying a 11.05% CAGR. The segments for hot-melt adhesives, photovoltaic (PV) adhesive films and electronic adhesives continue to enjoy robust growth. We think leading firms may increase market share as environmental policies and import substitution accelerate the exit of mid- and small-sized companies.

Wall cloths: Chinese market for wall cloths and wall paper combined reached a scale of around Rmb12.24bn in 2020. Consumption upgrade has encouraged use of high-end wall decoration materials. Wall cloths accounted for 74.7% of total sales volume of wall cloths and wall paper combined in 2020, far above the share of 6.4% seen in 2014. We think leading firms with advantages in products, distribution channels and brands are likely to increase market share.

Solid R&D strength, diversified product portfolios and quality customer resources give Shanghai Tianyang competitive advantages.

Solid R&D strength: The company has built strong R&D capabilities. It focuses on technological innovation of environmentally-friendly thermoplastic adhesive materials. Cooperating with universities, research institutes and other firms has enhanced Shanghai Tianyang’s technological strengths.

Diversified product portfolios: The company is further expanding applications areas of its products, by leveraging its expertise and production capacity of hot-melt adhesives. It has built diversified product portfolios and launched fast-growing business lines such as PV adhesive films, electronic adhesives and wall cloths.

Quality customer resources: In the adhesives segment for industrial applications, Shanghai Tianyang is continuing to increase market share by leveraging leading customers in PV adhesive film, electronic adhesives and wall cloth segments. In the segment for household applications, the company relies on brick-and-mortar stores, online channels and high-end property management firms to reach corporate and personal customers.

Organic growth and M&A create a bright future for Shanghai Tianyang, a leading producer of hot-melt adhesives.

Organic growth: The company plans to rapidly expand production capacity and to continue focusing on buoyant segments such as PV adhesive films and wall cloths. We think its new capacity may help the firm maintain strong growth momentum amid rising penetration rate of wall cloths and increasing demand for PV installation.

M&A: Shanghai Tianyang has built strong capabilities in resource integration. It has achieved synergies among existing resources by leveraging its advantages in technologies, production and distribution channels. We think the firm may expand product portfolios and maintain growth momentum through M&A.

How do we differ from the market? We think the market has underestimated growth prospect of the firm’s PV adhesive film and wall cloth businesses. We believe Shanghai Tianyang is a leading producer of hot-melt adhesives and enjoys a synergy among multiple businesses. In our view, the market also underestimates the company’s competitive advantages and scarcity value.

Potential catalysts: Strong growth in downstream demand; smooth production of new production facilities; further progress in M&A.

Financials and valuation

We expect the firm’s 2022-2023 EPS to be Rmb0.32 and Rmb0.72, implying a 48% CAGR. Initiate with an OUTPERFORM rating and a target price of Rmb12.8 (based on 18x 2023e P/E), implying 40% upside.

Risks

Negative surprises in end-market demand; lower-than-expected new capacity; raw material price volatility; cash flow risk.