Investment positives

We initiate coverage on Guanhao High-Tech with an OUTPERFORM rating and a target price of Rmb5.20, implying 19x 2023e and 15x 2024e P/E.

Why an OUTPERFORM rating?

SOE reform underway; high-quality white cardboard and specialty paper serve as dual growth drivers. Guanhao has established a solid foothold in the specialty paper market. After its merger with Foshan Huaxin Packaging-B in 2020 (a manufacturer of high-end white cardboard), differentiated specialty paper and high-end white cardboard became the core products of Guanhao. As of end-2022, its white cardboard, specialty paper, and coating capacity stood at 600,000t, 185,000t, and 270,000t. Its white cardboard business focuses on high-end food-grade cardboards and cigarette cards.

The firm’s specialty paper segment spans thermal and carbonless paper, thermal transfer paper, and self-adhesive labels. Its end-market customers mainly come from business communication, apparel printing and dyeing, and logistics sectors. The company announced an equity incentive plan in 2021, targeting a recurring net profit CAGR of no less than 15% over 2022-2024 based on its 2020 figure. Considering the consolidation of Foshan Huaxin Packaging in 2021, we estimate recurring net profit in 2022-2024 at no less than Rmb369mn, Rmb424mn, and Rmb487mn.

Coating technology lays foundation; differentiated products offer high price premiums. The company has expanded to the carbonless paper (focusing on finance, taxation, lottery, and banks) and cigarette cards (with China Tobacco as its key client) markets, both of which are highly concentrated with stable demand. The company has accelerated the development of thermal transfer printing and thermal paper amid the paperless trend, and started to leverage the core coating technology to achieve import substitution.

Backed by coating technology, the company has entered the differentiated high-end product market by leveraging its advantages in technology and distribution channels, obtaining a strong price premium, and consolidating its cost advantage through centralized procurement and self-sufficiency of raw materials. After merging with Foshan Huaxin Packaging, Guanhao has established a presence along the entire value chain, covering upstream chemicals (latex and calcium carbonate), midstream base paper (specialty paper and white cardboard) and downstream printing (offset printing and flexogravure printing).

Output at Zhanjiang Donghai Island facility to rise 40% YoY; cost reduction to mitigate cyclical fluctuations. Without production capacity expansion in 2021-2022, the company’s output increase during these two years has been mainly driven by the rising capacity utilization rate.

In 2023-2024, the company will continue to construct its new production facility at Zhanjiang Donghai Island: 1) Output - 300,000t of white cardboard and 60,000t of specialty paper to be added; paper output to rise more than 40% compared with end-2022. 2) Price - we believe the new white cardboard will mainly target the growing food-grade cardboard market. Meanwhile, the company has expanded its coating technology to new film-based materials, and we see ample room for price and profit growth. 3) Profit - we expect the company to inject 612,000t of Zhanjiang’s chemi-mechanical pulp assets over 2024-2025. If this is the case, the self-sufficiency rate of chemi-mechanical pulp in the food-grade cardboard segment may rise from 0% to 100%. Based on the average pulp price in 2022 and the self-production cost, we estimate that the company will save at least Rmb500/t in food-grade cardboard costs.

How do we differ from the market? The market has doubts about whether high paper prices may be sustained amid a sharp decline in pulp prices. We note that the firm focuses on high-end and differentiated products, and its customers are mainly strategic large clients (e.g., China Tobacco, Tetra Pak, and KFC). We are upbeat on the resilience of its product prices, and expect earnings to have upside potential in 2023.

Potential catalysts: Falling pulp and energy prices; on-stream operation of new capacity at Zhanjiang Donghai Island.

Financials and valuation

Our EPS forecast is Rmb0.28 and Rmb0.33 and 2023 and 2024, a CAGR of 26%. The stock is trading at 16x 2023e and 13x 2024e P/E. We initiate coverage with an OUTPERFORM rating and target price of Rmb5.2, implying 19x 2023e and 15x 2024e P/E and offering 17% upside.

Risks

Disappointing end-market demand and integration of Guanhao and Hongta; sharper-than-expected fluctuations in raw material prices; higher-than-expected industry-wide supply.