Domestic high-end decorative veneer materials leader. Dilong is engaged in the R&D, design, production and marketing of four major medium to high-end decorative veneer materials, i.e. decorative paper, high performance decorative panels, anodic alumina and the PVC decorative materials. Among them, decorative paper is its dominant product, representing 61% of its total turnover with the largest market share (3%) on mainland market. Boosted by sales volume growth and gross margin upturn, it rakes in Rmb617mn in turnover (+29.3% YoY), and Rmb57.65mn in net profit attributable to parent company (+42% YoY) in 2012. In 1H13, its turnover/net profit rose 20.9%/35.2% YoY.

Decorative paper veneer materials see a huge market potential amid the growing sectoral concentration. Decorative paper and other veneer materials are widely used in panel furniture, reinforced wooden flooring, wooden doors, vehicles, and other indoor decoration. Among others, panel furniture and reinforced wooden floor sectors consume ~95% of the decorative paper. On the back of accelerated urbanization, secondary decoration, and improving penetration rate of decorative paper, the decorative paper sector is expected to sustain a rapid growth of 20% over the next five years, and its market capacity is forecast to grow from current Rmb20bn to Rmb50bn in 2017E. Market concentration of the sector is relatively low at present, and the Company secures only ~3% market share as a sectoral leader. Going forward, as consumption upgrade advances and consumers attach increasing importance to brands and individualized designs and colour, leading companies’ market shares will keep improving amid increase of the sectoral concentration.

Outstanding brand and marketing advantages cater for customers’ “one-stop” service and individualized needs. The Company is committed to the brand strategy. Dilong decorative paper has become a renowned brand in the sector, the Company’s customer base basically covers most of the mainstream brand manufacturers at home; it has developed more than 15 regional-level agents (which are formerly the Company’s salesmen, ensuring relatively high loyalty) and more than 60 distributors, and also established business partnership with a large number of indoor decoration designers nationwide. With a wide range of products and the most abundant resources of printing roller design and colour resources (printing roller assets total Rmb100mn-plus), it caters for customers’ increasing demand for one-stop and individualized services, and its customer retention keeps growing.

Capacity expansion and gross margin bottoming-out boost rapid earnings growth. During 2010-11, the proportion of the Company’s revenues from alumina, decorative panels, PVC membrane, and other new products surged, but the capacity of these products remained in the initial period with relatively high unit cost, which dragged down its sales gross margin. As product sales volume surges going forward, decline in the unit cost will highlight economies of scale, and its overall sales gross margin is expected to rise accordingly. It completed a seasoned offering in Mar; after the projects financed with proceeds reach designed capacity, decorative paper/impregnated paper/decorative paper panel/PVC membrane capacity will soar 71%/62%74%/90%, which is expected to boost the high growth of sales volume. Additionally, its plants outside Zhejiang have begun to pay back, its market share in Western Europe share is growing rapidly, and new products will become important drivers for its rapid profit growth in the future.

Potential risks. (i) Real estate controls, and (ii) expansion into new markets.

Earnings forecast, valuation and investment rating. We forecast the Company’s 2013/14/15E EPS to be Rmb0.63/0.83/1.11 and net profit CAGR during 2013-15E to be 35%. The counter is trading at Rmb13.15 per share, implying 2013E PE of 21x. Given its high growth potential, we apply 2013E PE of 30x to it (implying target price of Rmb19 per share), and initiate its coverage with “BUY” rating.