The "breeze" of price increases seems to have failed to dispel the "cloud" of profit pressure hanging over the Pulp and Paper Sector.

On December 16, Hong Kong's Pulp and Paper stocks opened significantly higher, and at one point rose more than 4% during the session; by the close, the sector had risen 1.67% overall. Unfortunately, the "fruit of victory" from the sector's rise did not last long, as it was knocked back to its original state. On December 17 and 18, the sector saw consecutive declines, down 0.16% and 2.02% respectively. Looking at a longer time frame, since reaching a year-to-date high of 355.097 points, the Pulp and Paper Sector has cumulatively fallen over 23%.

(Industry source: Futu)

The "other side" of the sector's continuous decline in recent days is that several paperboard manufacturers have started raising prices as a form of "self-rescue".

Entering December, affected by the continuous rise in raw material costs, several paperboard manufacturers, including ND PAPER, have issued new price increase notices. Specifically, recently, ND PAPER (02689) has reported price increase notifications from its bases in Tianjin, Chongqing, Hebei, and Quanzhou, with price increases ranging from 30 yuan/ton to 80 yuan/ton. This is the first round of price increases for ND PAPER in December and, according to Statistics, it is the 12th round of price increases in the past three months. Not only ND PAPER but also several leading domestic paper companies such as Shanying International Holdings and LEE & MAN PAPER (02314) have recently implemented multiple rounds of price increases, with upward momentum still in place.

In recent years, the domestic Papermaking Industry has been struggling to cross the bottom of the industry cycle. However, under the pressure of the "three mountains"—high costs of wood pulp, continuous expansion of manufacturers on the supply side, and weak terminal demand—the industry's bottoming and recovery have not been "on the agenda" for a long time.

Nowadays, with multiple cardboard factories starting price increase "self-rescue" strategies, has the Papermaking Sector encountered an opportunity for a rebound?

With paper prices falling and costs remaining high, has Q3 profit hit bottom?

It is well-known that the core Indicators of the Papermaking industry are paper prices. The core factors determining whether paper prices increase or not depend on the supply and demand relationship, while the competitive landscape and profitability affect the elasticity and frequency of price changes. The profit space relies on the disparity between raw material prices and paper prices, with profits generally increasing during the upward slope of the pulp price in conjunction with rising paper prices.

In recent years, the main trend has been marked by the pulp price hitting bottom plus a turnaround in the slope as a starting signal, while the terminal paper price (where surface profits are visible, but underneath lies a supply-demand contradiction) determines the sustainability of the trend.

Reviewing the performance of the Papermaking Sector from Q1 to Q3 of 2024, it is easy to find that, due to the downstream demand recovery trend and pace being weaker than expected, most paper types have inventory levels based on a low expectation within channels. The pulp price has continuously risen to previous highs since the beginning of the year, but began to gradually decline since June, entering a downward channel affected by supply-side capacity releases and the end of Europe’s stockpiling since July 2024.

Due to the impact of inventory digestion, enterprise pulp costs in Q3 reached their peak for the year, while under the limited demand support, prices of most pulp series paper types have fallen in tandem with the current pulp prices, leading to a significant narrowing of profitability for most paper companies in Q3 2024 compared to Q2.

(Image source: Sinolink)

According to the Research Reports disclosed by Sinolink, in the first three quarters of 2024, the overall revenue growth rate of 13 key papermaking companies increased by 1.5% year-on-year, and due to the base effect, the net income attributable to the parent company saw a significant year-on-year increase of 51.1%, but on a quarterly basis, there was a slight decline.

Specifically, special paper and cultural paper benefited from a better competitive landscape, with earlier profitability stability being particularly prominent; however, Q3 still showed signs of profitability pressure. White card paper, waste paper sector, and others were affected by excess production capacity and the pace of recovery in downstream demand, leading to sluggish paper prices and continued pressure on profitability.

For example, taking the leading pulp and paper company, Shandong Sun Paper, from Q1 to Q3 of 2024, looking at each quarter, the company's gross margin and net margin both declined sequentially, with gross margins being 17.99%, 17.16%, and 13.96%, and net margins being 9.41%, 7.49%, and 6.74% respectively. At the same time, the profitability levels of most companies in the waste paper and special paper sectors gradually receded, for instance, Shanying International Holdings had gross margins of 9.88%, 7.82%, and 5.73% from Q1 to Q3 of 2024, while Wuzhou Special Paper Group's gross margins were 12.96%, 11.24%, and 10.68%.

(Image source: Sinolink)

It can be seen from the above that, as the paper prices in the papermaking industry decline and costs remain high, the fact that the profitability of paper companies continued to come under pressure in Q3 is an undeniable reality.

The recovery of demand is key; can the papermaking industry encounter opportunities for recovery?

Since the beginning of 2024, domestic demand and consumer confidence have continued to weaken. Although the price of pulp has increased in Q2 of 2024 due to supply disturbances, the relatively sluggish demand still exerts certain pressure on the profit margins. Looking ahead, as domestic policy stimuli take effect and overseas enters a cycle of rate cuts, pulp and paper demand is expected to warm up as consumer spending recovers.

Specifically, Q4 is the peak season for the papermaking industry with significant sales in September and October. Orders for autumn educational materials, as well as orders for household and packaging paper for the November 11 Shopping Festival-Related, are expected to boost demand. In September, the downstream paper mills are operating normally, but the demand side is expected to remain weak in the short term, with a slight recovery in pulp demand expected thereafter.

Looking at a longer time frame, from 2024 to 2025, new production capacities for finished paper in the domestic market may effectively accommodate some of the new pulp supply, and the support for consumer promotion and policies such as interest rate cuts and reserve requirement ratio reductions are strengthening. The basic economic situation and domestic demand show signs of bottoming out and improving expectations, and the policy support is expected to stabilize and rebound pulp demand.

As demand is the core element for market reversal, a gradual recovery of the industry is expected to follow the subsequent recovery of demand.

In this regard, Guosen pointed out that cultural paper profitability will be temporarily under pressure in Q3-Q4 of 2024, but with the subsequent low-priced pulp entering storage, profitability is expected to recover. For household paper, considerations regarding channels and competition strategy are necessary; overall, confidence in the profitability stability of cultural paper and household paper is relatively strong. White cards are facing a more severe supply-demand imbalance and potential competition that may weaken the recovery motivation of gross margin. The price of corrugated boxboard is expected to boost demand and improve profitability in the short term in Q4, while benefiting from economic recovery in the long term. Its elastic space is slightly larger than that of wood pulp but similarly, the competition and delayed elasticity on the cost side result in a longer window for profitability recovery.

Additionally, Sinolink stated that due to no new supply of broadleaf pulp being put into operation globally from 2025 to 2027, the judgment for a long-term upward trend in pulp prices is maintained. Furthermore, the expectation of demand recovery may become a key factor for stabilizing prices in the short term. The profitability performance of paper companies depends on differences in sub-sector structures, and large paper companies with strong cost control capabilities, foresighted wood pulp reserves, and leading positions in specialized paper segments like thin specialty paper are likely to demonstrate stronger profitability.

In such an industry context, several brokerage institutions have also provided some positive suggestions, recommending to focus on leading paper companies with cost advantages that continuously strengthen, as well as specialized paper companies in higher barrier segments with better performance. For instance, attention should be paid to Shandong Sun Paper, a large paper company with a forward-looking layout in the integrated wood-pulp-paper structure and excellent overall cost management; and specialized paper companies such as Hangzhou Huawang New Material Technology and Xianhe Co., Ltd. that have more favorable structures and stronger profit realization stability.

In summary, although pulp and paper stocks continue to feel pressure from the "three mountains" of cost, supply, and demand, profitability in Q3 remains under pressure. However, as the saying goes, "the wind and weather call for a long vision," looking at a longer timeline, alongside stabilizing and recovering pulp demand, pulp prices are expected to trend upwards in the medium to long term, which will further drive the recovery of profitability across the entire industry.