2Q24 results in line with our expectations

Wuzhou Special Paper Group announced its 1H24 results: In 1H24, revenue rose 21% YoY to Rmb3.43bn and net profit attributable to shareholders turned positive YoY to Rmb232mn. In 2Q24, revenue rose 8% YoY to Rmb1.71bn and attributable net profit reached Rmb99mn, in line with our expectations.

Sales volume slightly declined in 2Q24: In 1H24, the firm's paper production and sales volume were 581,000t (+21% YoY) and 566,000t (+33% YoY). We estimate that the sales volume in 2Q24 was approximately 280,000t, showing a slight QoQ decrease. During 2Q24, the per-tonne price increased only marginally QoQ, with partial implementation of price hikes for special paper, while food cardboard prices remained weak.

Net profit per tonne declined QoQ: The firm's actual pulp cost per tonne increased QoQ, surpassing the rise in paper prices, which pressured its earnings per tonne. We estimate that the firm's net profit per tonne was approximately Rmb350/t in 2Q24, with Glassine being the primary contributor to earnings. The firm has yet to achieve a cost advantage due to the high cost of 300,000t of chemical pulp at the Jiangxi production base.

Cash flow improving; capex remains high: In 1H24, net operating cash flow turned positive YoY, reaching Rmb220mn, while capex surged YoY to Rmb1.31bn, mainly due to the construction of new projects in Hubei. The firm previously announced plans to invest Rmb10bn in its Hubei production base. We expect cash flow and liabilities to remain under pressure over the next two years. The firm's gearing ratio stands at 71%.

Trends to watch

Price stabilization is key in 3Q24; earnings are likely to recover QoQ in 4Q24. Given rising inventory costs and weak demand in 3Q24, we do not expect paper price hikes to be sustainable. We expect that 3Q24 earnings will face notable pressure due to cost headwinds. Looking ahead, we expect earnings to recover QoQ in 4Q24, driven by the ramp-up of pulp and paper production capacity and a QoQ reduction in inventory costs.

Commodity paper and special paper businesses drove growth; new capacity in the Hubei base weighed on earnings in the near term. The firm's 300,000t/yr chemi-mechanical pulp project is ramping up, though its production costs are high in the short term. Looking ahead, we expect this project to meet Jiangxi's demand for printing and writing paper as well as food cardboard. We are optimistic about its potential cost advantage in core product categories.

In recent years, the firm has accelerated the construction of new production bases and expanded its product categories. In 2023, the firm added 22,000t of transfer printing paper, 300,000t of chemi-mechanical pulp, 18,000t of tracing paper, and 35,000t of industrial liner paper through M&A, diversifying its product portfolio. By the end of 2023, the firm had a raw paper capacity of 1.42mnt and a pulp capacity of 0.3mnt. In 1H24, the firm's Hubei production base began trial production of 300,000t of industrial packaging paper and 70,000t of bobbin paper. The firm's third industrial packaging paper project in Hubei (300,000t) is also in trial operation. The firm may exceed 2mnt by the end of 2023 (+40% YoY). However, we believe the current weak supply and demand in the packaging paper market may weigh on the firm's near-term earnings.

Financials and valuation

As new production capacity may weigh on earnings in the near term, we cut our 2024-2025 EPS forecasts 8% and 5% to Rmb1.27 and Rmb1.48. The stock is trading at 10x 2024e and 8x 2025e P/E. We maintain OUTPERFORM and cut our TP 25% to Rmb15 given falling risk appetite for the papermaking sector in 3Q24, implying 12x 2024e and 10x 2025e P/B, implying 25% upside.

Risks

Disappointing demand; sharper-than-expected fluctuations in pulp prices; new capacity weighing on earnings; deteriorating cash flow.