2Q24 earnings in line with our expectation

Xianhe announced its 1H24 results: Revenue rose 22% YoY to Rmb4,604mn and net profit attributable to shareholders grew 205% YoY to Rmb0.55bn in 1H24. In 2Q24, the firm’s revenue rose 24% YoY to Rmb2,395mn, net profit attributable to shareholders grew 381% YoY to Rmb282mn and recurring net profit grew 699% YoY to Rmb262mn, in line with our expectation.

Production and sales volumes of special paper products increased steadily: The firm announced that its production volume totaled about 0.55mnt (growing 22% YoY) and its sales volume was about 0.51mnt in 1H24. In particular, the firm’s production volume of special paper products was about 0.5mnt and its sales volume of special paper products rose more than 15% YoY to around 0.46mnt, continuing to grow steadily. Given weak market prices and earnings of ivory board products, the capacity utilization rate of the firm’s ivory board business remained low, and its production and sales volumes of ivory board products stood at about 47,600t and about 51,000t in 1H24 with losses of this business declining markedly.

Kingdecor’s net profit per tonne remained high: In 1H24, Kingdecor contributed investment income of Rmb99mn for Xianhe, implying net profit per tonne of more than Rmb1,000. We are upbeat on decorative raw paper products given their favorable supply and demand conditions, and we expect such products to continue contributing stable profits for Xianhe in 2H24.

Asset impairment losses slightly weighed on earnings: In 1H24, the firm’s asset impairment losses totaled Rmb33mn, mainly because selling prices of some products were lower than costs and the firm made loss provisions for falling prices of inventories. The firm’s credit impairment losses totaled Rmb13mn, mainly due to increased accounts receivable.

Net margin recovered YoY: In 2Q24, the firm’s net margin rose 8.7ppt YoY and edged down 0.4ppt QoQ to 11.8%, mainly because the firm has used up high-priced pulp inventories and the spread between pulp and paper prices boosted earnings amid low raw material costs.

Financial data: In 1H24, the firm’s net operating cash flow was Rmb77mn. The firm’s capex rose sharply YoY to Rmb2.3bn. The firm’s debt-to-asset ratio was 63%, largely flat HoH.

Trends to watch

Stabilizing prices to be crucial in 3Q24; earnings to receive a boost QoQ in 4Q24. We expect the firm’s actual pulp cost to rise slowly, and its profit per tonne to face pressure on a QoQ basis in 3Q24. Meanwhile, we do not think paper price hikes are sustainable and 3Q24 may offer an important window of opportunity for the firm to stabilize its product prices. If the firm’s efforts to stabilize product prices are effective, we expect its profit per tonne to recover QoQ and receive a boost in 4Q24 amid falling inventory pulp costs.

Production volume growth to continue; striving to establish an integrated presence in forest resources, pulp and paper products. Based on the firm’s announcement, its total production capacity has exceeded 1.6mnt as of 1H24, and the firm has three major production sites. The firm’s efforts to build its Hubei and Guangxi production sites have started to pay off. In 1H24, the firm put three papermaking production lines and two pulp production lines into operation in Hubei and Guangxi. We expect the firm’s papermaking capacity and pulp production capacity to increase by more than 0.5mnt in 2024.

We expect the firm’s production volume to rise more than 10% HoH in 2H24 and grow at a CAGR of over 15% after possible capacity ramp-up in 2025. In the medium and long term, we think establishing an integrated presence in forest resources, pulp and paper products will be the trend. Xianhe strives to expand its presence in upstream segments of the industry chain and strengthen its cost advantages. We are upbeat on Xianhe’s ability to reduce costs in the industry chain thanks to its efforts to expand product categories, increase production capacity, and strengthen its leading position.

Financials and valuation

We keep our 2024 and 2025 net profit forecasts unchanged. The stock is trading at 11x 2024e and 9x 2025e P/E. We maintain an OUTPERFORM rating. Given falling sector-wide valuation and risk appetite in 3Q24, we lower our target price by 7% to Rmb25, implying 16x 2024e and 14x 2025e P/E, offering 53% upside.

Risks

Disappointing demand; sharper-than-expected fluctuations in pulp prices; new supply higher than expected.