Description of the event

Incident 1: On June 17, 2024, Huafeng Chemical announced the 2023 profit distribution decision, with 10 payments of 1.50 yuan (tax included).

Incident 2: According to Baichuan Yingfu, the price of adipic acid has recently rebounded. As of June 21, 2024, the average market price increased by 2.72% month-on-month in June. The price of spandex continued to decline. As of June 21, 2024, the average market price in June fell 1.58% month-on-month.

Spandex is under pressure and supply-side pressure needs to be digested. Huafeng Chemical bucked the trend and rapidly increased its market share, and weak supply and demand for spandex led to a sharp drop in price. Combined with cost pressure, spandex profits fell sharply.

After the outbreak of COVID-19, spandex became an important raw material for the production of anti-epidemic materials and masks. In addition, the price of the raw material BDO rose rapidly due to a surge in demand for downstream PBAT, NMP, etc., causing the price of spandex 40D to once break through the 80,000 yuan/ton mark. High profits attract investment in additional production capacity. According to Baichuan Yingfu, in 2022, the country invested a total of 106,000 tons of production capacity, and 200,000 tons of production capacity was put into operation in 2023. The supply side put some pressure on market digestion. According to Baichuan statistics, more than 100,000 tons of production capacity will still be invested every year from 2024-2025. Due to supply-side pressure, demand falling short of expectations in 2023-2023, and a drop in raw material prices from a very high point, prices have almost dropped. Currently, the spandex boom is at the lowest level in history.

Currently, the drop in the spot price of spandex has slowed down somewhat. After more than two years of adjustments, the price of spandex has broken the break-even line of most companies, causing industry losses. It is at its lowest level in history since January 2020, and there is limited room for further decline. Furthermore, as production capacity investment slows down after 2025, the price of spandex is expected.

Production capacity clearance is accelerating, and leaders are bucking the trend and expanding, which is expected to create long-term opportunities. The spandex industry is experiencing a new round of industry challenges and opportunities. In the short term, there are pressures such as concentrated release of production capacity, pressure on environmental protection policies, and intensification of industry survival of the fittest, etc., but industry concentration is increasing year by year, and the leading effect on the industry is obvious.

According to Baichuan Yingfu, in 2023, the domestic spandex stock production capacity was 1.24 million tons, CR5 reached 78%, and the concentration of production capacity has increased dramatically. The company bucked the trend with its cost advantage. With the official launch of the company's differentiated spandex projects, profit flexibility is high in the next round. According to the 2023 annual report, the company still has 200,000 tons of spandex production capacity and is expected to gradually start production at the Chongqing base in 2024-2026. The company's Chongqing base has significant cost advantages over the same industry and Ruian base in terms of raw material costs, energy, and depreciation. With the gradual release of new production capacity at the Chongqing base, the spandex boom gradually picks up, and the company's profitability will continue to improve.

Adipic acid profits have improved slightly, and the current adipic acid industry pattern is stable, with Huafeng Group, Haili Chemical, and Pingmei Shenma taking the top three positions in terms of production capacity. Due to years of sluggish construction, the industry has added very little new production capacity. According to Baichuan Yingfu, the new production capacity in 2023 mainly comes from Huafeng Group's 400,000 tons of phase 5 and phase 6 adipic acid expansion projects announced in May 2021. In 2024, 200,000 tons of Hualu Hengsheng and 160,000 tons in Anhui Haoyuan are expected to reach production. There are no new production plans since then.

In Q1 2024, due to the continued rise in pure benzene prices on the raw material side, support on the cost side was strong, the price of adipic acid rose slightly, and overall supply and demand were stable. As of June 21, 2024, the average market price increased by 2.72% month-on-month in June, and there was a slight recovery in price and profitability.

In the medium to long term, the expansion of nylon 66 and PBAT production capacity is expected to drive up demand for adipic acid. The low operating rate on the supply side has significantly slowed the new production capacity of the adipic acid industry for many years. Huafeng Chemical's market share is close to 40%, and its bargaining power is strong. We believe that the adipic acid boom is expected to improve marginally in the next few years, and Huafeng Chemical will benefit the most.

Production capacity expansion continues to advance, and new production capacity is expected to contribute incrementally

Huafeng Chemical is the leader in the polyurethane industry chain, and the production capacity of products such as spandex, adipic acid, and polyurethane stock solutions is in a leading position. The company has significant advantages in industrial chain integration and leading cost advantages. Currently, the company's production capacity is progressing in an orderly manner. The project under construction is 200,000 tons of spandex, which is expected to be gradually put into operation at the Chongqing base from 2024-2026. The company's Chongqing base has significant cost advantages over the same industry and Ruian base in terms of raw material costs, energy, and depreciation.

Investment advice

We believe that the company's main business is marginally improving, while new production capacity will further consolidate its leading edge. Due to lower demand for major products than expected, net profit is expected to be 30.13 billion yuan, 35.30 billion yuan, and 4.439 billion yuan in 2024-2026 (the original forecast values for 2024-2025 were 39.49 billion yuan and 4.557 billion yuan), respectively. The current stock price corresponding to PE is 12.11, 10.33, and 8.22 times, respectively, maintaining a “buy” rating.

Risk warning

(1) The investment of new production capacity falls short of expectations;

(2) Prices of products and raw materials fluctuate greatly;

(3) The industry's production capacity investment exceeded expectations, and competition intensified;

(4) Production capacity of degradable plastics and nylon 66 fell short of expectations;

(5) Demand continues to decline due to the macroeconomic downturn.