2Q23 net profit beats market consensus

Rongsheng Environmental Protection Paper （Rongsheng） announced its 1H23 results: Revenue fell 13% YoY to Rmb1.13bn, and net profit attributable to shareholders rose 47% YoY to Rmb158mn. In 2Q23, revenue declined 15% YoY to Rmb585mn, and attributable net profit surged 180% YoY to Rmb76mn, beating market consensus thanks to resilient prices and effective cost control.

Comments

Falling paper prices weigh on revenue. Demand for packaging paper was tepid in 1H23. RISI reports that coupled with shock of paper imports1, this led to a decline more than Rmb300 industry-wide in corrugated paper prices. Compared to large papermaking firms that have a national presence and adopt a distribution model, medium-sized Rongsheng employs a direct sales model, which allows more resilience in prices.

Thus, the declines in its overall prices were milder than the industry average. The firm saw a QoQ decrease in prices in 2Q23.

Sales volume edged upward QoQ in 2Q23. Rongsheng strives to keep its turnover high, with its inventory turnover averaging 14 days in 1H23. It aims at running its facilities at full capacity and selling all products after production starts. We estimate the that sales volume exceeded 0.35mnt in 1H23, with a slight QoQ increase in 2Q23 sales volume mainly due to suspension of production during the Chinese New Year holiday in 1Q23.

Net profit per tonne fell slightly in 2Q23. We estimate net profit per tonne at Rmb450 in 1Q23. Given a sharper QoQ decline in paper prices than in costs of domestic old corrugated cardboard （OCC） and coal, we estimate that net profit per tonne fell QoQ in 2Q23 to more than Rmb350.

Financials solid. Operating cash flow rose 185% YoY in 1H23 to Rmb200mn, mainly due to a sharp YoY decline in OCC prices （a core raw material）。 Capex was Rmb50mn and near-term borrowings rose 106% YoY to Rmb620mn, as Rongsheng advanced construction of packaging and aramid paper production lines. Debt-to-asset ratio was 32%.

Trends to watch

Packaging paper sector to recover in 2H23; demand recovery to　boost paper prices. We believe that the packaging paper sector is on track for recovery. Paper manufacturers have announced two rounds of price hikes totaling Rmb60-80/t since August. Our survey shows that some paper makers have already begun to raise prices,. As the sector enters the peak season, and downstream clients begin replenishing inventories, we expect paper prices to rise from current trough.

Coupled with low raw material costs （i.e., domestic OCC and coal）， this may catalyze a HoH rebound in net profit per tonne of raw paper in 2H23, in our view. The firm announced that its Phase-I smart packaging industrial park project has begun operating. We expect the packaging paper production line to ramp up gradually, contributing incremental growth and strengthening the raw paper-packaging paper value chain.

Raw paper offers margin of safety; aramid paper to create a new growth driver. We believe that Rongsheng’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 Yangtze River Delta region supported by photovoltaic （PV） and combined heat & power （CHP） capacity to maximize its earnings.

We see substantial growth potential in sales volume and profit.

Rongsheng announced that it plans to build 2,000t of aramid paper capacity in a two-year construction period. We believe that the project will start production in 2024. We expect the firm to benefit fully from accelerated domestic production of and rapidly growing demand for aramid materials, possibly creating a new growth driver.

Financials and valuation

We keep our earnings forecasts unchanged. The stock is trading at 14x 2023e and 12x 2024e P/E. We maintain OUTPERFORM and our TP of Rmb18.00, implying 17x 2023e and 14x 2024e P/E with 18% upside.

Risks

Disappointing demand; slower-than-expected construction of new production base; sharper-than-expected fluctuations in raw material prices.