3Q24 earnings slightly miss our and market expectations

Huawang New Material Technology announced its 3Q24 results: In 1- 3Q24, the firm’s revenue fell 4.45% YoY to Rmb2.85bn, and net profit attributable to shareholders grew 2.94% YoY to Rmb409mn. In 3Q24, the firm’s revenue fell 19.4% YoY to Rmb905mn, and attributable net profit fell 34% YoY and 32% QoQ to Rmb106mn, missing our and market expectations due to rising inventory costs and declining production and sales volumes amid weak demand.

Lower-than-expected production and sales volumes: We estimate the firm's sales volume at around 75,000t in 3Q24 (vs. more than 80,000t in 2Q24 and 3Q23), falling YoY and QoQ mainly due to weak domestic and overseas demand and equipment maintenance in summer. In addition, the delay in the 80,000t production capacity scheduled to come online in early 3Q24 was also a reason behind the firm’s lower-than-expected earnings.

Price system relatively stable: The mid-range and high-end decorative base paper market where Huawang operates enjoys long-term favorable competitive landscape and supply and demand conditions, and product prices are relatively resilient. However, given the current weak performance of the market, the firm has adjusted the structure of its products in a timely manner and may cut prices for some products.

Net profit per tonne fell QoQ in 3Q24: We think that the firm's overall net profit per tonne declined slightly QoQ in 3Q24, mainly due to rising pulp inventory costs and possible product price cuts.

Attractive dividend: The firm previously announced an interim dividend payout ratio of 64.49% for 2024. Assuming that the full-year dividend payout ratio is the same as the interim dividend payout ratio, the firm’s current share price implies a 2024e dividend yield of 5.9%.

Solid quality of finances: In 1-3Q24, the firm’s operating cash flow was Rmb364mn, its capex was about Rmb160mn, and its debt-to-asset ratio was 36%.

Trends to watch

Upbeat on QoQ recovery in sales volume and profit in 4Q24. In the past few years, prices were stable for the firm's mid-range and high-end decorative base paper products and such products enjoyed favorable supply and demand conditions. However, domestic and overseas demand for such products is facing challenges, and pulp prices have fallen from high levels, which may put pressure on paper prices. Considering possible declines in inventory pulp costs in 4Q24 and the firm's 80,000t new production capacity (which we expect to contribute around 15,000t of incremental production in 2024), we expect the firm’s sales volume and net profit per tonne to recover in 4Q24.

Efforts to explore overseas markets to still boost growth potential. Based on our statistics, only Kingdecor and Huawang have added more than 400,000t of new production capacity since 2017 (vs. an increase of less than 100,000t in industry-wide demand). Leading companies are expanding their production capacity and maintaining high capacity utilization rates thanks to their rising market shares in the mid-range and high-end markets and overseas expansion. In the medium term, we are optimistic that leading companies will expand their presence in overseas markets. Coupled with the rising penetration rate of mid-range to high-end products in domestic market, we expect the new production capacity of Kingdecor and Xiawang to be digested. At the request of four European decorative base paper producers, the European Commission launched an anti-dumping investigation into Chinese decorative paper companies.

Huawang adopts a strategy of keeping product prices the same as those of European products, and prices of its some products may be higher than those of European products. In theory, this should not lead to vicious price competition. In addition, Huawang announced that its sales volume to the EU accounted for only a small single-digit share of its total sales volume in 2023. We expect the impact to be limited in the near term, and we suggest watching feedback from the EU.

Financials and valuation

Given delay in operation of new production capacity and weak demand, we cut our 2024 and 2025 net profit forecasts by 14% and 16% to Rmb547mn and Rmb589mn. The stock is trading at 11.5x 2024e and 10.6x 2025e P/E. We maintain OUTPERFORM rating and we cut our TP by 12% to Rmb15 (rolling over to 2025e valuation), implying 13x 2024e and 12x 2025e P/E and offering 11% upside.

Risks

Disappointing demand; sharper-than-expected fluctuations in costs; unexpected anti-dumping investigation.