XIANHE CO LTD(603733)：COST DECREASE MAY EXCEED EXPECTATIONS;EARNINGS MAY SEE HIGHER UPSIDE IN 2023

What's new
The domestic spot pulp price has been falling steadily since Suzano, a Brazilian pulp supplier, cut the price of eucalyptus pulp by US$40 to US$820/t on December 13, 2022. As the Arauco project has officially started production and the UPM project is progressing smoothly, offer prices in overseas markets may significantly decline in January-February, leading to a higher-than-expected cost decrease. We expect Xianhe’s net profit to grow at a CAGR of over 40% over 2022-2024. We believe the firm enjoys scarcity value as a high-quality stock with significant growth potential in the manufacturing sector, and we reiterate Xianhe as our top pick.
Comments
Cost decrease may exceed our expectations in 1H23 thanks to the rapid decline in pulp prices, a weakening US dollar, and falling energy costs. We note the signs of a high pulp inventory at major domestic ports. According to Europulp, pulp inventories continued to rise MoM in November 2022 in Europe. Meanwhile, Empresas Copec announced that Arauco's 1.56mnt/yr bleached eucalyptus pulp project had been put into operation. The UPM project is progressing smoothly, and the firm expects it to start operation in late 1Q23. In our view, the two global projects could be put into operation in 1Q23. As a result, the sharp declines in overseas pulp offer prices may continue. Furthermore, the weakening US dollar exchange rate and falling coal prices have lifted the pressure on paper mills' overseas pulp procurement (settled in US dollars) and energy costs. We expect paper mills' raw material and energy costs to decline in 1H23, and the cost decline may come earlier than expected, creating an upside surprise in 2023 earnings.
Diverse product mix and flexible production conversion to smooth the possible demand fluctuations. Xianhe's diversified products are mainly customized products with strong know-how and functions, leading to the high stickiness of its clients. Furthermore, with its multiple production lines, full coverage of product categories, and flexible production arrangement, Xianhe can better cope with demand fluctuations of specific products. For example, amid weak consumer demand and falling prices of paper products made from pulp and old corrugated containers in 2022, the firm's overall ASP still rose QoQ in 1-3Q22, proving its resilience in price and industrial cycles as a high-quality growth stock in the manufacturing industry. In 2023, we think the firm's high paper prices may decline amid falling pulp prices, but the decline may be narrower than that of paper products made from pulp and old corrugated containers and its peers.
We expect the sales volume to rise over 30% in 2023; significant capacity expansion to start in 2024-2025. We expect the firm's papermaking capacity to grow over 0.4mnt YoY in 2023 (over 1.5mnt in 2023 including Kingdecor) and full-year sales volume to grow over 30% YoY with capacity ramp-up. Furthermore, Xianhe may add 700,000t of pulp production capacity by the end of 2023 and start operation in 2024. By then, we expect the firm's self-sufficiency rate of wood pulp may grow from less than 15% to more than 50%. We expect this to mitigate cost fluctuations and stabilize profit margins amid rising pulp prices in the medium and long term. After 2024, we expect the firm will continue to build new pulp and paper production bases in Hubei and Guangxi. We expect sales volume to grow at a CAGR of over 20% in the medium term, profit margin to rise thanks to the development of new products, and Xianhe's advantages in the forest-pulp-paper value chain to pay off.
Financials and valuation
As cost pressure may continue in 4Q22, we cut our 2022 net profit forecast by 5% to Rmb778mn. As the pulp price may start to fall in 2023, we raise our 2023 earnings forecast by 15% to Rmb1.39bn, and introduce our 2024 earnings forecast at Rmb1.59bn. The stock is trading at 16x 2023e and 14x 2024e P/E. We maintain OUTPERFORM. Given the pressure in sector valuation, we maintain OUTPERFORM and our TP of Rmb35 (18x 2023e and 16x 2024e P/E), offering 15% upside.
Risks
Higher-than-expected wood chip and energy prices; end-market demand disappoints; new capacity higher than expected.
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   【免责声明】本文仅代表第三方观点，不代表和讯网立场。投资者据此操作，风险请自担。