Nanshan Fashion is a leading integrated player in the woolen textile and apparel industry. In 2022, the Company forayed into the field of ultra-high molecular weight polyethylene (UHMWPE). The first phase of 0.6kt UHMWPE production capacity was put into operation in Jun 2022, and the second phase of 3kt is set to be operational in 2H23. Looking ahead, the Company’s integrated advantages in its traditional business are well- established, and it is likely to maintain steady growth in the future. In the field of new materials, Nanshan Fashion is well-positioned with upstream supply and technological advantages, and its earnigns potential will gradually be released with the expansion of production capacity, leading to the high growth visibility. We initiate coverage with a “BUY” rating.

Expansion in new materials may bring about earnings elasticity. Nanshan Fashion is one of the few vertically integrated players in the woolen textile and apparel industry, covering fabrics and ready-to-wear clothing, which started to venture into the UHMWPE field in 2021. In 2022/1Q-3Q23, it achieved operating revenues of Rmb1,634mn/1,124mn (+9.5%/-5.21% YoY), respectively, and attributable net profit (ANP) of Rmb187mn/120mn (+22.51%/13.06% YoY).

The UHMWPE industry: Tight supply in the mid-to-high-end market, concentrated competitive landscape, and significant long-term application potential.

Currently, UHMWPE makes the fiber with highest level of strength and modulus in the world, widely used in military protection, marine industry, safety protection, and other fields. According to Qianzhan Industrial Research Institute (quoted from the prospectus of Tongyizhong New Material), the global demand for such products reached 98kt in 2020 while the real production totaled only 66kt, implying a tight supply in the mid-to-high end market in the short term. In the future, the demand will likely increase in line with the expansion in the application scenarios. Based on the predication of Qianzhan Industrial Research Institute, the demand may reach 165kt by 2025. Currently, the top ten global players occupy over 80% of the production capacity, with Chinese companies accounting for 60% of it. The high-end market presents high prices and strong profitability, primarily dominated by a few overseas leaders like DSM from the Netherlands, Honeywell from the US, and Toyobo from Japan. In recent years, domestic companies have been actively expanding production and positioning themselves in the high-end market, and they are likely to challenge overseas high-end market shares in the future.

New material business: Smooth capacity utilization and synergy with the parent group for a competitive advantage buildup. 1) Capacity release reach the level of top-tier players: Nanshan Fashion’s phase 1 capacity (0.6kt) and phase 2 capacity (3kt) have already been put into operation, making the Company one of the industry’s leaders in terms of production capacity and contributing Rmb25.14mn in revenue in 1H23. The Company’s focus on UHMWPE products target the mid-to-high-end market and boasts leading profitability, with a gross profit margin (GPM) of 33.8% in 1H23; 2) Synergy with the parent group platform to build competitive advantages: Yulong Petrochemical, the subsidiary of the Company’s parent Nanshan Group, is likely to create synergies with the Company in the new material business by a) assisting capacity expansion: High-quality UHMWPE fiber production has high requirements for raw materials. High-quality and stable raw material supply not only ensures support for the Company’s capacity expansion but also contributes to the improvement of product quality and yield; b) optimizing cost control: Collaborative sourcing of raw materials is likely to reduce the proportion of external raw material procurement, thereby aiding the Company in cost control; c) innovating collaboratively: Yulong’s petrochemical projects involve a wide range of products, including many industry-leading functional fiber raw materials. The Company is likely to collaborate with such projects for innovative development, expanding its range of functional fiber materials and establishing itself as a platform- oriented new materials company.

Woolen textile and apparel business: Empowering innovation with integrated industry chains, and boosting efficiency through intelligent transformation. 1) Fine woolen fabrics: Nanshan Fashion adopts an integrated production model that covers various stages of the industry chain, including woolen yarn processing, dyeing, spinning, fabric weaving, and finishing. Currently, the Company’s production capacity for fine worsted fabrics is 16,000 km, making it the second-largest in the industry. In recent years, along with its continuous efforts to enhance efficiency and develop new products (such as the high- value functional fabric OPTIM), the business GPM has increased from 26% in 2020 to 35.5% in 1H23. In the future, with the efficiency improvements brought about by technological upgrades, profitability is likely to remain robust. 2) Professional attire: Nanshan Fashion owns professional attire brands such as Dierma, Yushan, and Zhishang. These products are positioned in the mid-to-high-end market and maintain long-term supply relationships with central state-owned enterprises (SOEs), local SOEs, public institutions, and various well-known clothing brands. In 2022, the clothing business generated revenue of Rmb700mn, and it will likely continue to provide stable contributions in the future.

Potential risks: Intensified industry competition; lower-than-expected industry penetration rate; Less-than-expected capacity expansion; export policy risks; fluctuations in raw material prices; disappointing intelligent transformation; currency exchange rate fluctuations; increased labor costs; tighter oversight over environmental protection.

Investment strategy: Nanshan Fashion’s integrated advantage in traditional business is likely to boost the steady growth of the Company in the future. Additionally, in the field of new materials, leveraging upstream supply and technological advantages, it has the potential to gradually release earnings flexibility. We estimate the 2023E/24E/25E operating revenue at Rmb1.84bn/2.20bn/2.44bn (+12%/20%/11% YoY), and net profit of Rmb230mn/310mn/350mn (+25%/33%/12% YoY), respectively. Taking into consideration the Company’s solid foundation in the traditional textile sector and the significant growth potential in the new material business, as well as the average valuation of 17x 2024E PE (per Wind consensus estimates) for comparable companies namely, Giuseppe Garment (002687.SZ), Baoxiniao (002154.SZ), Tongyizhong New Material (688722.SH), Taihua New Material (603055.SH), Zhongfu Shenying (688295.SH), and Tayho Advanced Materials (002254.SZ), we assign 15x 2024E PE to derive a target price of Rmb13 by combining the 2.2x PB and initiate coverage with a “BUY” rating.