Incident 1: On April 25, 2024, Dongfang Shenghong released its 2023 annual report. The company's 2023 revenue was 140.404 billion yuan, up 119.87% year on year; net profit to mother was 717 million yuan, up 17.35% year on year; net profit after deducting non-net profit was 217 million yuan, up 155.20% year on year.

Incident 2: On April 29, 2024, the company released its report for the first quarter of 2024. The company's 1Q24 revenue was 36.739 billion yuan, up 24.34% year on year, down 0.61% month on month; net profit to mother was 247 million yuan, down 66.53% year on year, up 114.01% month on month.

Comment: Inventory impairment affects the company's short-term performance. The company's overall gross sales margin in 2023 was 11.27%, up 3.60 pcts from the same period last year. The company's financial expenses rose 75.73% year on year in 2023, mainly due to increased interest expenses; sales expenses rose 74.75% year on year, mainly due to increased employee remuneration and storage expenses; R&D expenses rose 33.46% year on year, mainly due to increased R&D investment.

The company's net profit margin in 2023 was 0.51%, down 0.34pcts from the same period in 2022. The sharp year-on-year increase in the company's revenue in 2023 was mainly due to the full commissioning of Shenghong Refining & Chemical, a wholly-owned subsidiary of the company, and achieved revenue of nearly 100 billion yuan in the first year of operation. The year-on-year decline in the company's net interest rate in 2023 was mainly due to falling energy prices such as natural gas and the prices of most petrochemical products, causing the entire petrochemical industry to “increase production and sales without increasing profit” in 2023. In addition, in 2023, the company accrued losses of 2,210 billion yuan due to inventory price declines, of which inventory products, raw materials, in-process products and semi-finished products amounted to 1.72 billion yuan, 277 million yuan, and 175 million yuan respectively. In the first quarter of 2024, the company experienced asset depreciation of 504 million yuan, all due to inventory price depreciation losses. 1Q24 asset impairment losses still had a certain impact on the company's profitability.

Net cash flow from the company's operating activities rose sharply year over year in 2023. The net cash flow from the company's operating activities in 2023 was 8.343 billion yuan, up 379.00% year on year. The main reason was the year-on-year increase in cash received from selling goods and providing services. Net cash flow from investment activities was -22.046 billion yuan, up 33.74% year-on-year, mainly due to a decrease in cash payments for the purchase and construction of fixed assets. Net cash flow from fund-raising activities was $9,983 billion, down 68.47% year on year. The main reason was that private fund-raising was not carried out and the net inflow of loans declined. The balance of cash and cash equivalents at the end of the period was $6.386 billion, a year-on-year decrease of 37.18%. Accounts receivable rose 110.70% year over year, mainly due to increased sales and increased customer accounts receivable. The accounts receivable turnover increased from 104.14 times in the same period in 2022 to 129.21 times. Inventory turnover increased from 4.99 times in the same period in 2022 to 6.97 times.

The production capacity of the company's refining and chemical business was fully released, and Shenghong Refining & Chemical's revenue was close to 100 billion dollars. As of December 2023, China's total refining capacity reached 936 million tons/year, ranking first in the world. The concentration and scale of the industry has further increased. Among them, the number of refineries of 10 million tons and above has increased to 36. 2023 is the first full year of production capacity of Shenghong's 16 million tons/year integrated refining and chemical project. The main products include basic chemical products such as 1.1 million tons/year of ethylene, 2.8 million tons/year of p-xylene, 1.9 million tons/year of ethylene glycol, 300,000 tons/year of vinyl acetate, and 400/250,000 tons/year of phenol/acetone. The load on refining plants gradually increased in the first quarter of 2023. Starting in the second quarter, key processes including normal pressure reduction, aromatic hydrocarbons, and ethylene all reached or were close to full capacity. Eventually, the crude oil processing capacity for the whole of 2023 reached 15.8 million tons. In 2023, Shenghong Refining and Chemical achieved revenue of 99.193 billion yuan and net profit of nearly 481 million yuan. In the future, the company plans to go from “full” to “excellent” to further enhance the profitability of Shenghong Refining and Chemical.

Focus on the new energy and new materials business and deepen the “1+N” industrial layout. According to “Dongfang Shenghong Investor Relations Management Information 20240507”, the company made breakthrough progress in many new energy new material products in 2023. In terms of lithium battery materials, the fourth acrylonitrile plant was put into operation, and the total production capacity rose to 1.04 million tons/year, becoming number one in the world; the self-developed POE pilot test was successful, and the construction of a 100,000 tons/year industrialized plant is being implemented; in terms of lithium battery materials, EC/DMC, ultra-high molecular weight polyethylene and other projects are being implemented in 2023 It was built and put into operation one after another; 130,000 tons/year of PETG's new high-end polyester material will also be put into operation in 2023.

Sierbon Petrochemical is the company's chemical new energy and new materials operator. In 2023, Sierbon Petrochemical's revenue was 16.948 billion yuan and net profit was 751 million yuan. According to the company's 2023 annual report, as of 2023, Sirbon Petrochemical had 2.4 million tons/year MTO unit (in terms of methanol), making it the largest single alcohol-based co-generation plant in the world. Among downstream high-end olefin derivatives, Sierbon Petrochemical has an EVA production capacity of 300,000 tons/year, which is mainly used to produce photovoltaic grade EVA, and has the highest market share in the world. We believe that in the future, the company will continue to focus on the field of new energy and new materials, deepen the “1+N” layout, and further expand the company's business growth space.

The filament industry is gradually recovering, and the gross profit of recycled polyester fiber is high. According to “Oriental Shenghong Investor Relations Management Information 20240506”, as of the end of 2023, the company had a total production capacity of 3.55 million tons of polyester filament, including 550,000 tons of recycled polyester fiber. Shenghong Chemical Fiber had revenue of 24.088 billion yuan and net profit of 107 million yuan. In terms of product gross margin, the gross profit margin of polyester filament is 5.68%, which is basically consistent with other leading companies in the industry; judging from the product structure, the phased market for POY/FDY products in 2023 was relatively good, but DTY, which accounts for a relatively high proportion of the company's filament products, showed relatively weak performance, and the gross margin level was higher than that of other filament varieties. From an industry perspective, it is expected that the filament industry will maintain a slow recovery trend in the future as the pace of new production capacity investment in the polyester filament industry slows down and demand in the downstream textile and garment sector continues to recover. Continuing our view in our previous report “The pattern of the polyester filament industry is becoming concentrated, and profits in the polyester industry chain are expected to shift to the long silk end”, we expect that poor filament production capacity will be overburdened by costs or will gradually clear up, industry sentiment is expected to rise, and as industry concentration continues to increase, the integrated cost advantage of leading enterprises will also become more and more prominent.

Investment advice: The company is expected to achieve operating income of 1525.60/164.9.07/174.078 billion yuan in 2024-2026, and realized net profit of 32.16/45.67/6.080 billion yuan respectively, corresponding EPS of 0.49/0.69/0.92 yuan, respectively. The PE multiples corresponding to the current stock price are 19.9X, 14.0X, and 10.5X, respectively. Based on the following aspects, 1) Shenghong's production capacity is fully released, and its profitability is expected to increase further as the company continues to deepen its “1+N” layout, and many new energy new material products have achieved breakthrough progress to help the company grow in the future; 3) the prosperity of the filament industry is expected to rise, and the company's recycled polyester fiber is performing well. We are optimistic about the increase in the profit level of Shenghong Refining and Chemical and the launch of new energy and new material products, and maintain a “buy” rating.

Risk warning: risk of raw material price fluctuations; downstream demand falling short of expectations; market competition heightens risks; new construction projects are progressing less than expected; and risks such as exchange rate fluctuations.