Key points of investment:

The company released the 2023 annual report and the 2024 quarterly report: 1) In 2023, the company achieved revenue of 1,556 million yuan (YoY -9.7%), realized net profit of 220 million yuan (YoY -37.76%), and realized net profit of about 217 million yuan (YoY -37.54%), of which 23Q4 achieved revenue of 378 million yuan (YoY -3.5%, QoQ -11.8%), and realized net profit to mother of 9.32 million yuan (YoY -119%, 23Q3 about 72.62 million yuan). Non-return net profit was about 11.49 million yuan (YoY -125%, 23Q3 about 70.92 million yuan), and the performance was lower than expected. 2) In the first quarter of 2024, revenue of 435 million yuan (YoY +16.1%, QoQ +15.3%) was achieved, net profit attributable to mother was about 53.6 million yuan (YoY -26.4%, loss reversed month-on-month), and realized net profit of about 51.23 million yuan (YoY -26.3%, loss reversed month-on-month). The performance was in line with expectations.

Cellulose ether sales increased steadily, prices declined due to domestic demand and raw materials, and the bottom of capsule sales rebounded quarter by quarter. According to the annual report, 1) The company's cellulose ether production and sales volume in 2023 was about 46,000 tons (YoY +26.3%) and 40,400 tons (YoY +16.6%), respectively. The main increase was due to the company's expansion of cellulose ether production capacity in 2023, as well as the gradual recovery of overseas demand and the company's increasing customer demand. Prices are due to the continuous decline in the prices of upstream raw materials such as refined cotton, cotton pulp, methylene chloride, and propane oxide. As the prices of products declined, domestic demand was still at a weak level, and the price of cellulose ether declined year on year.

In addition, due to the gradual transformation of 20,000 tons of building material-grade cellulose ether and 10,000 tons of food-grade pharmaceutical-grade cellulose ether added in the second half of 2023, depreciation costs have dragged down gross profit margins. Overall, the company's cellulose ether revenue fell 2.6% year on year to 11.275 billion yuan in 2023, and gross margin fell 5.02 pct year on year to 25.52% year on year.

2) Vegetable capsule sales rebounded at the bottom of 2023. Overall, the company's vegetable capsule production and sales volume in 2023 was about 13.13 billion tablets (YoY -15.6%) and 11.02 billion tablets (YoY -8.1%), achieving revenue of about 246 million yuan (YoY -10.9%), mainly due to short-term price disturbances in demand and supply. Gross margin was also declining due to falling costs, increasing by about 0.8 pct to 55% year-on-year. 3) In terms of other business, the company discontinued production of Fukugawa's original trimethyl acetate products, and plans to stop production in the future. Overall, the company's gross margin fell 4.91 pct to 29.29% year on year in 2023. On the cost side, the overall sales expense ratio, management expense ratio, and R&D expense ratio increased by 0.95 pct year on year. In terms of financial expenses, financial expenses increased year-on-year in 2023 due to an increase in interest costs for debt conversion and a decrease of more than 12 million yuan in exchange earnings. Furthermore, due to the discontinuation of production of original trimethyl acetate products, the estimated impairment value of production equipment exceeded 20 million yuan. Overall, the net profit margin for 2023 was 6.38pct YoY to 14.15%.

The price of vitamin ether continued to fall in Q4, compounded by the cost impact of previous production capacity conversion, and profitability declined. Furthermore, Q4 calculated impairment losses, resulting in losses.

According to Baichuan data, the prices of cotton pulp, propane oxide, and methane chloride, which are the main raw materials of 23Q4 cellulose ether, fell 13.9%, 1.0%, and 2.4% month-on-month respectively. Overall raw material prices declined slightly month-on-month, so the price of cellulose ether continued to drop slightly. Furthermore, at the end of last year, the company expanded production of 20,000 tons of building material-grade cellulose ether and 10,000 tons of food and pharmaceutical-grade cellulose ether, and gradually entered the consolidation phase in the third quarter. Furthermore, due to a month-on-month decline in vegetable capsule shipments at the end of the year, the overall impact on gross margin for the fourth quarter was 6.22pct month-on-month to 24.2%. On the cost side, mainly due to an increase in management expenses of more than 20 million yuan at the end of the year and the discontinuation of production of original trimethyl acetate products, impairment losses of production equipment exceeded 20 million yuan at the end of the year. Overall, the net profit margin fell 19.43 pcts to -2.47% month-on-month.

Q1 Cellulose ether prices and costs are still under pressure. Capsule sales have reached a record high, and profits have gradually recovered. According to Baichuan data, the prices of cotton pulp, propylene oxide, and methane chloride, which are the main raw materials of 24Q1 cellulose ether, fell 11.3%, 2.1%, and 12.4%, respectively. Combined with relatively weak domestic demand, prices are still under pressure. The vegetable capsule pattern gradually improved. Combined with the completion of downstream warehousing and a recovery in consumption capacity, record high capsule sales in the first quarter led to a month-on-month increase in profitability. In 24Q1, the company's gross margin increased by about 0.86pct month-on-month to 25.06%. On the cost side, the overall three fees and impairment losses were significantly reduced month-on-month, thus driving the net profit margin back to 12.31% month-on-month.

The gradual transformation of cellulose ether in the construction project contributed to the increase, and the acquisition layout of hydroxyethyl cellulose ether was extended to improve the product category. By the end of the first quarter of 2024, the company's projects and fixed assets were about 174 million yuan and 2,123 million yuan respectively. The main projects under construction were 5,000 tons/year hydroxyethyl cellulose projects. The company acquired Zhongfuji in 2023 to expand the layout of hydroxyethyl cellulose ether and improve the product category. Second-generation capsules have been verified, and the share is expected to gradually increase in the future. The company successfully registered second-generation capsules and obtained 2 national invention patents, which have been widely recognized by domestic and foreign customers. It is expected that future breakthroughs will be made in pharmaceutical customers. Furthermore, as demand gradually picks up, the company's vegetable capsule sales are expected to increase significantly year-on-year in 2024.

Profit forecast and investment rating: Considering that the price of cellulose ether has declined in the short term and related costs and expenses due to the transformation of construction projects, the profit forecast for 2024-2025 was lowered, and the profit forecast for 2026 was added. The estimated three-year net profit to mother is about 3.1, 3.9 (original forecast was 360 million yuan and 410 million yuan), and 490 million yuan. The corresponding PE is 17, 13, and 10 times, respectively, maintaining the “increase” rating.

Risk warning: Cellulose ether production capacity falls short of expectations; vegetable capsule pattern deteriorates; large fluctuations in raw materials affect profit levels. Furthermore, on January 2, the company received an announcement that executives received the “Advance Notice of Administrative Penalty” and “Administrative Penalty Decision” from the China Securities Regulatory Commission to pay attention to related risks.