Zhongtong Caijing APP learned that Minsheng Securities has released a research report stating that under the background of pressure on pulp prices, companies such as household paper (C&S Paper Co., Ltd., Hengan International, etc.), special paper enterprises (Hangzhou Huawang New Material Technology, Xianhe Co., Ltd., etc.), on the one hand, the proportion of pulp production capacity in the above companies is relatively low, and on the other hand, paper product prices have strong resilience, and profit improvement can be expected. At the same time, for integrated paper industry chain companies like Shandong Sun Paper, papermaking as a more profitable business, Minsheng Securities believes that pulp layout is not the main factor for the company to continue to obtain excess returns, because pulp is also a traditional manufacturing industry, and it is difficult to maintain a long-term excess ROE. Instead, through industrial chain integration, it helps the company smooth out the cycle, counter-cyclically maintain stable cash flow and accelerate expansion, and can also increase profitability in line with the industry in a cyclical manner, allowing the company to operate normally and steadily increase market share.

The main points of the Minsheng Securities report are as follows:

The current characteristics of pulp: easy to rise and difficult to fall, and volatility has increased. Previously, pulp was a global commodity with relatively small volatility, especially in terms of volatility or active pricing, which was inferior to other cyclical products. The main reason is that pulp demand is a consumer product, which is relatively stable. Price fluctuations are more affected by the supply release rhythm. Since 2019, the pulp price has shown a relatively strong performance, mainly manifested as: 1) easy to rise and difficult to fall. Under the background of new production capacity release in 2019, pulp stayed at the bottom for only nearly two months and quickly returned to a new high. Pulp prices remained at a high point for nearly two years from 2021 to 2023. 2) Volatility has increased significantly. In the previous downward cycle, the pulp price climb cycle lasted for 1-2 years. The cycle of price adjustment for each cycle was 3-6 months. Compared with other global commodities priced in US dollars, pulp has shown stronger volatility since 2019 and stronger price resilience over time at a high level. The profit center of pulp enterprises and the increase in volatility; for example, Suzano's net profit margin (47%/35%) in 2022/2023 reached a historic high, and its net profit margin in 2021 reached a historic low (-21%). Before 2018, the low/high points of Suzano's net profit margin in 2008/2009 were -11%/24%, respectively.

With many uncertainties and disturbances, the listing of pulp futures exacerbates the volatility of pulp prices. In the previous cycle, the economies of Europe, America and China resonated, and the price of pulp bottomed out for a long time. In this cycle, affected by public health incidents and differentiation of the Chinese and American economic cycles, such as the overseas demand pressure in 2020 due to public health incidents, China benefited from good public health prevention and control, and used pulp demand to hedge against insufficient overseas demand. In 2020, China's pulp imports increased by the same amount as the previous year by 13%. By 2024, domestic paper companies have obviously slowed down in pulp procurement, but Europe has entered a cycle of replenishing warehouses. In 2023, the amount of needle/broadleaf pulp sent from W20 (the top 20 global pulp suppliers) to China dropped from the previous high point of 40%/45% to 20%/35%. Europe was also affected by the Red Sea incident, and pulp began an active replenishment cycle. Pulp enterprises actively increased their shipments to Europe and America. On the other hand, pulp futures, which were listed in November 2018, saw an increase in speculative positions. The center of pulp price rises: the concentration of broadleaf pulp, while the main reason for the rise in the center of needle pulp prices is the combination of supply contraction and cost increase.

We expect the short-term price of needle pulp to be under pressure, and the adjustment space of the US dollar price is greater than that of spot prices: 1) the futures price reflects part of the cash flow cost of the production area: According to the main contract price of pulp futures on July 15th was 5,738 yuan/ton, corresponding to about 690 USD/ton overseas prices, which is the cash flow cost of Western Canada and the British Columbia Province (which corresponds to more than 10% of production capacity); 2) the domestic spot price has a discount of 400 yuan. The spot price (Yinxing) has dropped from 6,500 yuan/ton to 6,100 yuan/ton, which is still lower than the SP2409 contract by nearly 400 yuan. We expect that there is still room for downward adjustment; 3) Foreign price has not yet adjusted, and the Yinxing US dollar price is still at 820 USD/ton, more than 10% higher than the domestic spot price, with greater adjustment space. From a medium-to-long-term perspective, we are bullish on the center of needle pulp prices moving up: 1) industry new production capacity remains stable (only 1.14 million tons will be put into operation from 2023 to 2026); 2) the center of needlewood prices has a certain support for upward movement on the cost side; 3) in the past few years, the proportion of broadleaf pulp in papermaking formulas has gradually increased.

Short-term downward pressure on broadleaf pulp is greater than that on coniferous pulp, and the upward elasticity in the medium and long term is weaker than that of coniferous pulp. 1) The domestic price of broadleaf pulp is still far from the global cash flow cost of broadleaf pulp production: as of July 8, 2024, the price difference between domestic and foreign broadleaf pulp exceeds 700 yuan, but there is still some room for cash flow cost from the world's highest-cost producing areas. We believe that short-term foreign quotes will continue to move lower, while spot prices still have a downward range; 2) The price difference between coniferous and broadleaf pulp has gradually widened: using coniferous pulp as the anchor, the current price difference between coniferous and broadleaf pulp is 450 yuan/ton, and it was more than 1000 yuan/ton in the past. It is expected that the price difference between coniferous and broadleaf pulp will further widen and return to a reasonable level in the future. In the medium term, the central price will rise, but the elasticity is not as good as coniferous pulp: 1. Similar to coniferous pulp, the logic of upward central pressure on broadleaf pulp is still valid with the upward trend of log prices, but considering that the elasticity of broadleaf wood prices is weaker than that of coniferous wood, the expected upward movement of the central price is also weaker than that of coniferous pulp; 2. At present, the expansion of broadleaf pulp production capacity is mainly for non-head pulp enterprises, and the concentration of the industry chain fluctuates, which may have certain disturbance to the bargaining power of the industry.

The bottom support of wood chips, and pulp prices are difficult to return to the previous low point. From the perspective of raw material prices, the central price of broadleaf/ coniferous wood is gradually rising (the average price of broadleaf wood chips in the first five months of 2024 is 0.19 US dollars/kg, an increase of 13% compared to the same period in 2016). There is still room for an increase in inventory of Sino-European pulp, so the space for pulp price decline is relatively limited.

Investment advice: under the background of pulp price pressure, for household paper companies (such as C&S Paper Co., Ltd., Hengan Int'l, and etc.) and special paper companies (such as Hangzhou Huawang New Material Technology, Xianhe Co.,Ltd., etc.), on the one hand, pulp accounts for a relatively low proportion of production capacity in the above companies, on the other hand, paper prices have strong resilience, and profit improvement is expected. At the same time, for integrated companies in the industry chain like Shandong Sun Paper, papermaking is a larger and stronger business. We believe that pulp layout is not the main factor for the company to continuously obtain excess profits because pulp is also a traditional manufacturing industry and it is difficult to maintain excess ROE in the long term. But through the integration of the industry chain, the company can help smooth the cycle, maintain stable cash flow in the anti-cyclical period, accelerate expansion, and synchronously increase profits with the industry during the cyclical period; making the company operate normally and achieve steady market share growth.

Risk warning: downstream demand is lower than expected, and upstream resource products are affected by natural disasters.