Investment positives

We initiate coverage on Rongsheng Environmental Protection Paper （Rongsheng） with an OUTPERFORM rating and an SOTP-based target price of Rmb18.00, implying 14x 2024e P/E.

Why an OUTPERFORM rating?

A regional packaging paper leader focusing on the YRD region and seeking differentiation backed by channel and cost advantages. Headquartered in Pinghu, Zhejiang province, Rongsheng focuses on the Yangtze River Delta （YRD） region and has achieved integrated production and sales of packaging products. As of 2022, Rongsheng had 0.6mnt/yr of raw paper capacity and 250mn sqm of corrugated board and supporting combined heat & power （CHP） capacity.

The firm is a medium-sized packaging paper leader in the YRD region. It has focused on cutting costs and increasing profits over the past few years as the paper sector bottomed, and thus now enjoys industry-leading net profit per tonne. Compared with large papermaking firms that have a national presence and adopt a distribution model, medium-sized Rongsheng employs a direct sales model and targets over 100 of long-tail customers in the YRD region. We believe this allows for more flexibility in its operation as well resilience in its prices.

Domestic production of aramid materials on the rise to drive new growth. Aramid paper is a high-performance new material used in high-end manufacturing （including the power and electrical, aerospace, and rail transit industries）。 The US-based DuPont is the world’s largest aramid paper supplier, accounting for 60% of nominal capacity globally in 2022. Domestic production of aramid materials is also on the rise.

Aramid paper is characterized by hard-to-obtain raw materials, high technological barriers to entry in terms of preparation, and stringent customer verification. It is costly but generates high profit margins. Rongsheng announced that it plans to build 2,000t　　of aramid paper capacity in a two-year construction period. If the project reaches its design capacity as scheduled and achieves stable sales, we expect the firm’s new material business to ramp up over 2024-2025, boosting its profit and valuation.

Raw paper offers a margin of safety; aramid paper to create a new growth driver. We believe the packaging paper sector is on track for recovery, and the firm’s resilience against the sector bottom in 2022 provided a margin of safety. The firm plans to build a new production base in Quanjiao （Anhui province） to strengthen its raw paper-packaging paper value chain. It plans to build two production bases in the YRD region supported by photovoltaic （PV） and CHP capacity to maximize its earnings. We see substantial growth potential in the firm’s sales volume and profit. We also expect the firm to fully benefit from accelerated domestic production of and fast-growing demand for aramid materials, which may create a new growth driver.

How do we differ from the market? We believe Rongsheng’s main business of packaging paper is on track for recovery, providing the firm with a margin of safety. We also expect the ramp-up of the firm’s new material business to further boost its profit and valuation.

Potential catalysts: Aramid material capacity starts production; paper prices rebound amid mild recovery in demand.

Financials and valuation

We forecast EPS at Rmb1.09 in 2023 and Rmb1.31 in 2024, a CAGR of 47%. The stock is trading at 15x 2023e and 13x 2024e P/E. We initiate coverage with an OUTPERFORM rating and a target price of Rmb18, implying 17x 2023e and 14x 2024e P/E with 9% upside.

Risks

New capacity expansion and/or demand fall short of expectations; cost hikes sharper than expected; investment income fluctuates.