The 2023 results slightly exceeded expectations, and the improvement in industry supply and demand is expected to continue to achieve net profit attributable to the parent company of HK$1.05 billion in 2023, -11.3% year-on-year, slightly exceeding market expectations (Visible Alpha's agreed forecast: HK$990 million). Thanks to seasonal improvements in demand in the second half of the year and marginal restoration of the supply-demand relationship, 2H23 net profit was +92% yoy/+142% month-on-month respectively to HK$740 million, which ushered in the first same/month-on-month improvement since 2H20. We expect supply shocks in the wrapping paper industry to ease in 2024, and the improvement in supply and demand relationships is expected to continue. Maintaining the 2024/2025 EPS forecast of HK$0.31/0.33, the 2026 EPS is forecast to be HK$0.30, and the target price will increase 2% to HK$4.63, based on 0.7x2024 P/B (2024BVPS: HK$6.61), which is one standard deviation lower than the average since 2010 to reflect the decline in the industry's demand growth center. Maintain a “buy” based on the company's cost advantage and undervaluation.

2H23 sales accelerated, net profit bottomed out and rebounded

2H23 sold 3.52 million tons of pulp and paper, +11.1% year over year, faster than 1H23 (+3.4% year over year). Net profit per ton (net of profit attributable to perpetual bond holders) was HK$211 per tonne, up HK$89 per tonne and HK$109 per ton year over month, respectively. Improved gross margins and better control of marketing and management expenses offset the rise in financial expenses. The profitability improvement in the 2H23 wrapping paper business was moderate, with an operating profit margin of +1.8pct to 4.9% month-on-month; while the profit improvement in the household paper business was significant, with an operating profit margin of +15.4pct to 24.8% month-on-month.

The supply shock in the corrugated board industry is expected to ease in 2024

Due to the concentrated release of new production capacity and the rapid growth of imported finished paper, 1H23 in the box board corrugated paper industry is still under heavy operating pressure, but with the recovery in 2H23 demand, industry profits have bottomed out and rebounded. We expect the supply shock to the industry to ease in 2024, and the improvement in the supply and demand relationship in the industry is expected to continue, which is conducive to a further recovery in the profitability of the company's wrapping paper business. With the marginal recovery in overseas wood pulp prices since 4Q23 and the acceleration of household paper production capacity, we expect that the company's operating profit margin for household paper may be under pressure in 2024.

Deepening vertical integration is conducive to cost control optimization

With the launch of the company's production capacity of Malaysian wrapping paper and Guangxi household paper, the company's wrapping paper and household paper production capacity reached 7.58 million tons/year and 1.1 million tons/year respectively by the end of 2023, continuing to maintain the first tier position in the industry. In 2023, the company will put into operation a total of 950,000 tons/year of wood pulp production capacity in Chongqing, Jiangxi and Guangxi, increasing the company's share of fiber/paper production capacity from 12% at the end of 2022 to 22% at the end of 2023. We expect the deepening of vertical integration to help the company stabilize the supply of raw materials and better control costs.

Risk warning: Consumption is picking up more slowly than expected, exports are steadily slower than expected, and supply investment is stronger than expected.