Investment positives

We initiate coverage on Yueyang Forest & Paper Co., Ltd. （Yueyang） with an OUTPERFORM rating and a target price of Rmb8.00 based on P/E valuation methodology, corresponding to 23x 2023e and 18x 2024e P/E.

Why an OUTPERFORM rating?

An investment target making solid progress; on track to benefit from central SOE reforms at start point of new boom cycle. Yueyang

focuses on the printing and writing （P&W） paper and packaging paper businesses, and has expanded into chemical, landscaping, and forest development businesses amid its efforts to integrate forestry, pulp, and paper operations.

Yueyang's parent company, China Paper, is the only central SOE that has been approved by the State-owned Assets Supervision and Administration Commission （SASAC） to focus on the integration of forestry, pulp, and paper operations. The actual controller of China Paper is China Chengtong and the ultimate controller is the SASAC, which is under the State Council. In recent years, subsidiaries of China Chengtong have carried out capital market reforms.

Yueyang announced an equity incentive plan in 2020. In May 2023, it released plans for private placement （it plans to raise Rmb2.5bn and the firm’s major shareholder China Paper intends to subscribe to 10-30% of the shares） and introduce a share repurchase plan （it plans to buy back Rmb50-100mn of shares and cancel the shares after the buyback）。

Core P&W paper business growing steadily; forestry-pulp-paper integration to help smooth out cyclicality. The firm targets mid-range to

high-end learning and education orders, and it outshines peers in terms of price resilience and stability. In addition, the firm carries out effective refined management. For example, the firm produces 50% of the chemi- mechanical pulp （CMP） it uses in-house and purchases the remainder through China Paper. Although the industry’s cost per tonne rose more than 30% YoY in 2022, the firm's cost per tonne increased by 16%.

As of end-2022, Yueyang had production capacity of 850,000t of P&W paper and 150,000t of packaging paper. The firm plans to put into operation 450,000t of high-end P&W paper production capacity by 4Q24.

We believe the firm's papermaking capacity could double during the 14th Five-Year Plan （FYP） period driven by resource consolidation. In the medium and long term, we are upbeat on the firm’s growth prospects, with the pulp and paper businesses as its “cash cow”， and as it gives full play to competitive advantages in forestry-pulp-paper integration to smooth out cyclical fluctuations in papermaking, and improve average net profit per tonne.

CCER to go from zero to one; market size to surpass Rmb20bn after

reopening. China Certified Emission Reduction （CCER） is an effective supplementary tool for carbon emission allowances （CEA） under the framework of carbon neutrality. The scheme was suspended in 2017 and was limited to a small number of existing carbon allowances. Given the steady progress in achieving carbon neutrality and expectations of a shortage of allowances, we are optimistic that CCER will be reopened in the next few years, and we expect market demand to surpass Rmb20bn by the end of the 14th FYP period.

As of May 2023, Yueyang had about 0.13mn hectares of self-owned forest, 2.31mn hectares of contracted forestry carbon sink projects, and around 0.17mn hectares of farmland carbon sink operation projects （which makes it a leader in the domestic market）。 In addition, the firm has a special bank loan scheme in which it has borrowed Rmb1.5bn to support project development. We are optimistic that Yueyang will rapidly ramp up its carbon sink business to release growth potential after the CCER scheme is restarted.

How do we differ from the market? The firm is trading at a valuation premium over its peers. We believe that as a mid-range to high-end P&W paper leader and a CCER frontrunner in terms of reserves, the firm’s valuation is reasonable, and the recent corrections might offer buying opportunities.

Potential catalysts: CCER reopening; sharper-than-expected decline in pulp prices; and rising demand for P&W paper.

Financials and valuation

Our EPS forecast is Rmb0.35 for 2023 and Rmb0.44 for 2024, a CAGR of 14%. The stock is trading at 19x 2023e and 15x 2024e P/E. We initiate coverage with an OUTPERFORM rating and a TP of Rmb8.00, corresponding to 23x 2023e and 18x 2024e P/E, and implying 20% upside.

Risks

Disappointing end-market demand; higher-than-expected new supply in the industry; sharper-than-expected rise in raw material prices; reversibility risk of forest carbon sinks; short-term cash flow pressure.