Key points of investment:

The company released its 2024 mid-year report: In the first half of the year, it achieved revenue of 0.935 billion yuan (YoY +24.6%), achieved net profit of 0.124 billion yuan (YoY -21%), and realized net profit of 0.116 billion yuan (YoY -26.2%); of these, 24Q2 achieved revenue of 0.5 billion yuan (YoY +33.2%, QoQ +14.8%), and achieved net profit to mother of 70.32 million yuan (YoY -16.4%). QoQ +31.2%) achieved net profit of 65.16 million yuan (YoY -26.2%, QoQ +27.2%) after deduction, and the performance was in line with expectations.

Revenue and sales of the company's main business cellulose ether and vegetable capsules both increased significantly year-on-year in the first half of the year, and profitability is estimated to have declined due to the introduction of new production capacity. According to the company's interim report, 1) Cellulose ether products achieved revenue of 0.695 billion yuan (YoY +16.4%) in the first half of the year, mainly due to the company's new production of 0.02 million tons of building materials and 0.01 million tons of food and pharmaceutical-grade production capacity at the end of 2023, and sales increased year-on-year. However, due to the fact that the prices of the main raw materials refined cotton, cotton pulp, chloromethane, and propane oxide declined in the first half of the year. In addition, the price of the company's products also declined in the first half of the year. Due to increased costs, the gross margin of cellulose ether fell by about 8.72 pct to 20.5% year on year in the first half of the year; 2) Vegetable capsules achieved revenue of 0.155 billion yuan (YoY +55.5%) in the first half of the year, and Hershey, a subsidiary mainly based on vegetable capsules, achieved revenue of 0.2 billion yuan (YoY +50.5%) in the first half of the year, and achieved a net profit of close to 70 million yuan (YoY +73%), mainly due to the company's increased market development efforts, which led to a marked increase in production capacity utilization. The increase resulted in a 4.14pct year-on-year increase in the gross margin of capsules to 57.3% in the first half of the year. Affected by the gross margin of cellulose ether, the company's gross margin fell 5.23 pct year on year to 25.99% in the first half of the year. On the expense side, the company's sales expense ratio declined by nearly 1 pct year on year in the first half of the year. The management expense ratio increased by 0.7 pct due to increases in labor costs and depreciation expenses. Financial expenses increased due to a decrease in exchange income of 7-8 million yuan and the calculation of debt conversion expenses, so the overall net profit margin decreased by 7.66 pct to 13.25% year on year.

Sales of vegetable capsules and cellulose ether continued to increase in the second quarter, and profitability gradually recovered due to the increase in the production capacity utilization rate of various products. The capacity utilization rate of new production capacity continued to increase in the second quarter. We expect the utilization rate of new building materials to reach close to 70% and food and pharmaceutical grade to about 30%. Prices of main raw materials are still declining, so product prices may drop slightly from month to month. Vegetable capsules are estimated to have reached a record high sales volume in Q2, and capacity utilization continues to increase. Overall, Q2 gross margin increased 1.74 pcts month-on-month to 26.8%, and net profit margin increased 1.76 pcts month-on-month to 14.07%.

Cellulose ether has been extended horizontally, and capsule profits still have room to rise. The company acquired Zhongfuheda in 2023 to achieve a horizontal extension to enhance the company's R&D, production, sales and service capabilities for hydroxyethyl cellulose (HEC). Currently, Zhongfuheda has a HEC production capacity of 0.01 million tons, and is one of the largest HEC manufacturers in China. HEC thickens and has better water retention effects. Downstream can also be used in oil fields, household chemicals and other fields. In the future, with the continuous increase in capacity utilization and the gradual promotion of second-generation capsules, profitability is expected to rise again. As of the end of June 2024, the company's projects under construction decreased by 0.12 billion yuan compared to the end of March, mainly for the 5,000 tons/year hydroxyethyl cellulose project.

Profit forecast and valuation: Considering that the gross margin of building material-grade cellulose ether is affected by the shift in production capacity, the profit forecast for 2024 was slightly lowered, and the profit forecast for 2025-2026 was maintained. The estimated three-year net profit to mother is about 2.8 (original forecast 0.31 billion yuan), 0.39, and 0.49 billion yuan, respectively, corresponding to PE about 14, 10, and 8 times, 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