2Q23 earnings miss our and market expectations

Guanhao High-Tech announced its 1H23 results: Revenue fell 10% YoY to Rmb3.45bn. Net profit attributable to shareholders fell 134% YoY to Rmb50.32mn. Net profit attributable to shareholders turned to a loss of Rmb58.26mn in 2Q23, missing our and market expectations due to weak demand for white cardboard and steeper-than-expected price declines.

Comments:

Steeper-than-expected decline in white cardboard prices; price adjustment for heat transfer base paper: Due to weak supply and demand and rapid decline in cost of pulp, white cardboard prices continued to decline QoQ in 2Q23 (we estimate a decline of more than Rmb500/t). Due to intensifying competition and rapid cost decline, price of thermal transfer paper fell by more than Rmb2,000/t and that of specialty paper fell by Rmb1,000 QoQ in 2Q23.

Sales volume of specialty paper stable and cigarette card shipments recovering: The cigarette card sales volume fell slightly in 1Q23 due to the revision of the QR code on cigarette packets, but recovered in 2Q23. Shipments of specialty paper remained stable QoQ, and we estimate sales volume of white cardboard and specialty paper at 200,000t in 2Q23, up 20% QoQ.

Milder-than-expected cost reduction: As the firm continued to consume high-priced pulp in 2Q23, the pace of cost reduction was milder than expected, and profit margin of paper products weakened QoQ due to weak demand.

Financial expenses turned negative due to large FX gains: Due to the appreciation of the US dollar and the adjustment of foreign currency asset structure, financial expenses fell to -Rmb9.29mn in 1H23 due to large FX gains.

Cash flow under short-term pressure: Net operating cash flow turned negative YoY to -Rmb340mn in 1H23, mainly due to inventory increasing. Debt-to-asset ratio was 36% in 1H23.

Trends to watch

Large stock buyback boosts market confidence; 2H23 earnings upside gradually confirmed. The company announced that it plans to use its own funds to buy back Rmb200-400mn of shares at a price of up to Rmb5, and all the repurchased shares will be cancelled, which will boost market confidence, in our view. Meanwhile, the dividend payout ratio is as high as 119% in 2022, providing solid support to share price. As the company begins to use low-price pulp and the downside of current low paper prices is limited, we expect earnings to gradually rise in 2H23.

Capacity expansion to start in 2024; supporting chemi-mechanical pulp to strengthen cost advantage. The company is steadily building its Zhanjiang Donghai Island production facility:

Volume: 300,000t of white cardboard and 60,000t of specialty paper will be added, and the volume of papermaking will increase 40% compared with end-2022;

Price: We believe the new white cardboard will mainly target the booming food card segment. The company has also expanded its coating technology to new film-based materials. We expect organic growth to remain solid, and expect M&A to become increasingly visible. We see ample upside in price and profit in the medium term.

Profit: We estimate that some of chemi-mechanical pulp production (about 400,000t) will come online in 2025, and the self-sufficiency rate of food card chemi-mechanical pulp may rise from the current 0% to 100%. This should be conducive to consolidating the company's cost advantage and strengthening profitability of its flagship products, in our view.

Financials and valuation

Given pressure on white cardboard prices and profit margin, we cut our 2023 and 2024 earnings forecasts by 28% and 11% to Rmb332mn and Rmb495mn. The stock is trading at 20x 2023e and 13x 2024e P/E. We maintain OUTPERFORM rating and cut our target price 10% to Rmb4.7, implying 26x 2023e and 18x 2024e P/E, implying 31% upside.

Risks

Weaker-than-expected demand; supply of new white cardboard higher than expected; sharper-than-expected fluctuations in costs.