1H23 attributable net loss was Rmb12.15mn, lower than our forecast

Wuzhou Special Paper Group (Wuzhou) announced that in 1H23, revenue dropped 4% YoY to Rmb2.84bn, and net profit attributable to shareholders came in at -Rmb12.15mn (down 106% YoY). In 2Q23, revenue and attributable net profit were Rmb1.58bn and Rmb17.68mn. Its attributable net profit turned positive in 2Q23, while the firm booked an attributable net loss in 1Q23. Its 2Q23 results were in line with our expectations.

Prices of food cardboards and ivory boards declined rapidly; production volume dropped as the firm upgraded technologies for bulk paper manufacturing machines: Ivory board prices　slumped, due to weak demand and expectations around incremental production capacity. RISI data shows that the average price of ivory boards dropped more than Rmb600/t HoH in 1H23. Lower ivory board prices weighed on food cardboard prices at the company.Sales volume fell 14% YoY in 1H23 to around 426,000t, due to weak demand, and the firm's efforts to upgrade technologies for the printing and writing paper production line in Jiangxi. We estimate that such efforts eroded production volume by around 50,000t in 1H23.

High-priced pulp inventories, investment loss, and foreign exchange loss weighed on earnings: The firm did not benefit from　lower pulp prices in April and May, as it continued to utilize high- priced pulp inventories during those months. Its futures investment incurred losses of more than Rmb19mn, due to sharp declines in pulp prices in 2Q23. In addition, we think the firm recorded high foreign exchange losses in 1H23, as its payment for pulp was settled in US dollars.

Cash flows came under pressure; capex remained high: Net　operating cash flow came in at -Rmb220mn in 1H23 (the firm recorded positive net operating cash flow in 1H22), as Wuzhou purchased low-priced pulp, and customers increased notes receivable and loan settlement in 1H23. Capex remained high, as the firm accelerated construction of production bases in Jiangxi and Hubei. In 1H23, its capex reached Rmb510mn and asset-liability ratio stood at 71%.

Trends to watch

Private placement to drive a valuation recovery; earnings to recover　in 3Q23. At end-June 2023, Wuzhou announced plans to raise no more than Rmb850mn through a private placement. The firm’s actual controller intends to subscribe in full to the new shares. A precondition for granting is that recurring attributable net profit reaches Rmb250mn, Rmb550mn, and Rmb700mn in 2023-2025. Our view is that the planned share purchase reflects two issues. First, Wuzhou's major shareholder thinks the firm’s valuation has reached its nadir. Second, the major shareholder is confident about the firm’s medium-to-long-term development.

In our view, paper prices have limited downside in 3Q23. The firm has recently announced price hikes for glassine and transfer paper. Sales volume will likely increase QoQ in the upcoming peak season. In addition, the firm has utilized low-priced raw materials since June. We think the company may enter a recovery cycle in 3Q23 and we see substantial QoQ upside potential.

Increasing production capacity by acquiring other companies and launching new projects; integration and diversification ahead.

Acquisition: Kan Specialities Material announced that it sold a 75% stake in Kaifeng Special Paper (Kaifeng) to Wuzhou. Kaifeng is located in Quzhou, Zhejiang. We see strong synergies between the locations of Kaifeng and Wuzhou. We think the acquisition can help Wuzhou improve its product mix, as the former operates the lining paper business.

New projects: The firm expects its 300,000t/yr chemi-mechanical pulp project in Jiangxi to start operating in 4Q23, as its 500,000t/yr food cardboard CMP capacity in Jiangxi can largely meet demand.

The company also expects to start building its Phase I project in Hubei in 1H24. Once this project starts production, we think it will enrich Wuzhou’s product portfolio, elevating its sales volume and profit to new highs.

Financials and valuation

We keep our earnings forecasts and target price unchanged. The stock is trading at 21x 2023e and 10x 2024e P/E. We maintain an OUTPERFORM rating and our TP of Rmb20. Our TP implies 28x 2023e and 13x 2024e P/E, offering 33% upside.

Risks

Demand disappoints; capacity expansion beats expectations; pulp prices and/or energy prices fluctuate more sharply than expected.