2Q24 results largely in line with our expectations

Sun Paper announced its 1H24 results: Revenue rose 6.11% YoY to Rmb20.5bn in 1H24 and net profit attributable to shareholders grew 40.5% YoY to Rmb1.76bn. In 2Q24, net profit attributable to shareholders grew 17% YoY and fell 16% QoQ to Rmb802mn, in line with our expectations.

1) P&W paper: We estimate that the average net profit per tonne edged down QoQ but stayed above Rmb400/t in 2Q24 amid peak season and a slight rise in pulp cost per tonne. Looking ahead, we believe net profit per tonne could witness a slight decline due to the low sustainability of price hikes, rising pulp cost per tonne in 3Q24, and commencement of 450,000t production capacity at Yueyang Forest & Paper in late-2024.

2) Packaging paper: In 1H24, amid the rising prices of old corrugated cardboard (OCC) from the US, we estimate net profit per tonne at the Laos production base was weak, and the decline in domestic paper prices was also a drag on net profit per tonne. Looking ahead, we expect net profit per tonne to recover steadily in 3Q24, backed by potential price hikes during the peak season for packaging paper in the second half of the year and the optimization of production lines in Nanning, Guangxi.

3) Dissolving pulp: Thanks to favorable supply and demand conditions, the price of dissolving pulp stayed at Rmb7,700/t in 2Q24 and did not fall sharply along with pulp prices; profit per tonne remained high overall. Looking ahead, we are upbeat on the resilience of dissolving pulp prices in 2H24, which will offering support to net profit per tonne.

4) Other pulp products marketed to external parties: Pulp prices have fallen from high levels since 2Q24. We expect profit per tonne of the firm's pulp products marketed to external parties to decline QoQ in 2Q-3Q24. However, the volatility should be limited as the firm sells pulp products mainly to the group.

5) Balance sheet sound; asset impairment a short-term drag: In 1H24, the gain or loss from disposal of non-current assets was -Rmb87mn, mainly from the Nanning base. We note that the Nanning base is a project acquired previously with old facilities, and we note that the risk of impairment could remain during the construction of new projects in the next few quarters. Operating cash flow was Rmb3bn in 1H24, capex was Rmb2.4bn, and liability-to-assets ratio was 47%.

Trends to watch

3Q24 earnings under pressure QoQ; upbeat on a recovery in 4Q24. We estimate that the firm's full-year paper sales volume will rise more than 10% YoY thanks to the ramp-up of 1mnt linerboard production facilities and the 150,000t household paper project slated for operation in 3Q24. The firm announced its plan to add 400,000t of specialty paper, 350,000t of chemical pulp, and 150,000t of chemi-mechanical pulp (CMP) production capacity to its Phase II project in Nanning. A 37,000t specialty paper-based new material project and the Phase II of a 140,000t specialty paper project in Shandong have started construction.

We expect the firm's capex to remain high in 2024-25, underscoring the need to reserve sufficient cash for organic growth. In addition, we expect inventory costs to rise in 3Q24. Taking into account the weak demand and low sustainability of rice hikes, we expect profit per tonne to weaken QoQ in 3Q24, and stabilizing paper prices will be the firm's main strategy in 3Q24, in our view. However, we believe profit per tonne could stabilize QoQ in 4Q24 thanks to price hikes and low pulp inventories.

Improving forest-pulp-paper integration. Sun Paper's paper-pulp production capacity now exceeds 12mnt. It is the only company in China that has integrated forest-pulp-paper production capacity and covers all types of paper products. Sun Paper has demonstrated its ability to look far ahead and aim high, maintain cost advantages through cost reduction, and expand business during industry downturns. In the medium term, we are upbeat that the firm will continue to solidify its cost advantages, backed by its strong presence in Shandong and Guangxi, abundant forest resources, and high-quality fiber in Laos.

Financials and valuation

In view of the drag from asset impairment, we cut our 2024 and 2025 net profit forecasts 13% and 18% to Rmb3.2bn and Rmb3.5bn, implying 10.4x 2024e and 9.7x 2025e P/E. We maintain OUTPERFORM and our target price of Rmb18, implying 16x 2024e and 15x 2025e P/B and offering 49% upside, considering the firm is a high-quality stock with good long-term growth prospect and it enjoys cost advantage backed by pulp-paper business integration.

Risks

Weaker-than-expected demand; higher-than-expected new production capacity; sharper-than-expected fluctuations in pulp prices.