1Q23 results missed our expectations and consensus

Guanhao High-Tech announced its 1Q23 results: Revenue fell 5% YoY to Rmb1.63bn. Net profit attributable to shareholders fell 79% YoY to Rmb7.94mn, missing our expectations and consensus due to higher-than-expected cost pressure.

Our comments:

1） Weak sales volume in the slack season; resilient prices for mid-range and high-end products: We estimate sales volume fell more than 15% YoY and QoQ in 1Q23 due to weak domestic demand and exports. Most food and cigarette cards （accounting for more than 80% of white cardboard sales volume） and specialty paper （we estimate 1Q23 sales volume at 40,000-50,000t） are directly supplied to major clients, and their prices are resilient. However, we expect prices of cyclical social cards （accounting for less than 10% of white cardboard sales volume） and self-adhesive labels （we estimate 1Q23 sales volume at 20,000t） to drop markedly QoQ. Overall, weak sales volume was the key reason for the YoY revenue decline in 1Q23.

2） Net profit per tonne of white cardboard bottoming out: In 1Q23, the firm still used the high-priced pulp it purchased in 4Q22, and prices of some social card products weakened. As a result, the white cardboard segment suffered losses. We estimate a net loss per tonne of Rmb50-100, which was the main drag on 1Q23 earnings.

3） Operating cash flow was under temporary pressure; ample room for leverage: In 1Q23, operating cash flow was under temporary pressure, falling 284% YoY to -Rmb584mn due to stockpiling of low-price pulp. Financial expenses fell Rmb4mn YoY. The liability-to-asset ratio and net gearing ratio stood at 29% and 3%, indicating ample room for increasing leverage. The firm plans to invest Rmb1.35bn to expand its papermaking capacity by 360,000t, most of which we think can be funded by its own cash flow.

Trends to watch

Costs to decline from 2Q23; white cardboard to recover. Since the start of 2Q23, we believe industry leaders have ended the stagflation cycle that lasted for several quarters, and have entered the stage of cost reduction. According to our survey, the firm has used up its inventory of high-priced pulp and is gradually using the low-priced pulp it purchased in early 2023.

Meanwhile, prices of most white cardboard and specialty paper are resilient. For example, the firm usually signs orders with customers at the end of each year, with stable sales volume and prices largely locked in, implying that most of the cost reduction in 2023 will be reflected in the recovery of net profit per tonne. We are upbeat on earnings generated from the spread between pulp and paper prices over 2-3Q23. In particular, we see ample upside to earnings from the white cardboard sector, which has hit a trough.

Production capacity to expand in 2024. The firm continues to expand its new production base in Donghai Island, Zhanjiang, and we are optimistic that by end-2024, the firm will achieve the following:

1） Output: We believe 300,000t of white cardboard and 60,000t of specialty paper will be added, and papermaking volume will increase 40% compared with end-2022;

2） Price: We believe the new white cardboard will mainly target the growing food card segment. Meanwhile, the firm has expanded its coating technology to film-based new materials. The organic growth remains solid. We expect M&A to become increasingly visible. We see ample room for price and profit growth in the medium term.

3） Profit: We expect China Paper （the firm’s parent company） to add 612,000t of production capacity for chemi-mechanical pulp over 2024-2025, and that the firm’s self-sufficiency ratio of food cardboard chemi-mechanical pulp may rise from 0% currently to 100%, which should strengthen the profitability of Guanhao High-Tech’s flagship products and mitigate cyclical fluctuations.

Financials and valuation

Given higher-than-expected cost pressure in 1Q23, we cut our 2023 and 2024 earnings forecasts 10% and 11% to Rmb463mn and Rmb553mn. The stock is trading at 17x 2023e and 14x 2024e P/E. Given recovering risk appetite in the papermaking sector in 2Q23, we maintain OUTPERFORM rating and target price of Rmb5.2, implying 21x 2023e and 17x 2024e P/E, and offering 22% upside.

Risks

Disappointing end-market demand; sharper-than-expected decline in pulp prices; higher-than-expected supply growth.