China packaging paper sector

Transcription

1 E 2017E Equity Research Maintain Neutral China packaging paper sector Publication date 28 September 2016 Recommendations Company Code Rating Lee & Man Paper 2314 HK Hold Nine Dragon Paper 2689 HK Hold Source: Huatai HK Research estimates Sector performance 25,000 20,000 15,000 10,000 Jan-15 Jun-15 Nov-15 Apr-16 Source: Bloomberg, Huatai HK Research estimates Chart / table (mn tonnes) Source: China Paper Association, Huatai HK Research estimates Sector profile China s packaging paper industry is still quite fragmented, with leading players even losing market share. The industry has experienced low single digit demand growth since 2012, despite the positive contribution from the e-commerce industry. The supply side is still a concern, given a strong projects pipeline and waning positive effects from retirement of obsolete capacity. Analyst Jie GONG +(86) gongjie@htsc.com Liang YU +(86) yuliang@htsc.com Huatai Paper Index Rel. to HSCEI (rhs) (%) (15) (30) Container board (lhs) (yoy%) Container board growth (rhs) (6) Key takeaways from East China paper industry trip On our East China visit last week to four paper mills, an OCC supplier and a paper packaging producer, we found market sentiment was upbeat, a reflection of robust sales and low inventory levels. However, the heated market is mostly due to industry re-stocking rather than demand boost, and will not be enough to counter the profit margin shrinkage in 3Q16 prompted by higher raw material price. We reiterate our Neutral call on the China packaging paper sector as it is still only weakly balanced due to sluggish overall demand and strong capacity addition. Strong sentiment on industry re-stocking rather than demand boost While we look for paper price to be hiked by another RMB50/t for October, the heated market is mostly due to industry re-stocking, in our view, as paper production and transportation were both affected during the G20 summit. Downstream demand is insufficient to support a sustainable improvement in profitability, and producers are concerned about demand after the National Day holiday. Profit margin narrowed in 3Q16 on higher raw material prices, though a recent cooling in old corrugated container (OCC) price brought some relief. Reiterate Neutral on the China packaging paper sector as the industry is still weakly balanced due to sluggish overall demand and strong capacity addition. Better shipment achieved on cross-regional S-D rebalance Most paper mills we visited in East China have achieved better sales this year, thanks to sales growth at customers in South China. Year to date, demand from local customers (East China) has been largely flat while the sales volume has declined year on year for producers whose customers are mainly in the export or appliance industries. However, given the paper price premium in South China over East China has widened paper prices were hiked more in South China in 2015 on mill closures demand from customers in South China increased, helping paper producers in East China record better sales this year. Price hike execution differentiated and largely cost driven Paper mills in East China started to hike prices in June but execution differed greatly among producers. One of the paper mills we visited achieved an average price hike of around RMB150/t; meanwhile, however, its raw material price rose by RMB200/t. The other paper mills we visited achieved only a RMB50/t hike. Mills in East China are about to hike the price by RMB50/t for October. Though most producers expect a smoothly executed hike this time around, it is still cost driven as the new cargo weight rule released by the Ministry of Transportation may lift transportation cost by around RMB30/t, if fully implemented. Huatai Financial Holdings (Hong Kong) Limited is abbreviated as Huatai HK throughout this report. 1 Please refer to end pages for analyst certification and required disclosures.

2 Key takeaways from the tour Company A Company profile. Company A is a waste paper retailer and a subsidiary of a large US paper producer. It collects 6mn tonnes of waste paper in the US annually, of which half is used by its parent company and half is exported. Demand. Waste paper export volume year to date by Company A is roughly the same as that in 9M15. Most customers are mid-small paper manufacturers as large producers always have their own subsidiary for waste paper collection and procurement. Most of Company A s orders come from the purchase of US OCC. US OCC price. Company A has been a price taker rather than a price maker in the US OCC market this year. US OCC supply has been sufficient in 2016, with no big negative events that could have hurt supply. The major reason for the US OCC price surge, despite the stable supply this year, is increased purchasing from the big three paper producers. Transportation cost for imported US OCC is about USD10/t. Domestic OCC. The previous decline in volume of domestic OCC collected is probably a result of flooding. Outlook for demand in 4Q16. In terms of OCC demand, 4Q16 may be a slack season because paper producers who failed to renew their OCC Import License will not purchase imported OCC if the products cannot arrive in China by the end of Outlook for US OCC price. The bankruptcy of a Korean shipping company may result in an increase in the transportation cost for US OCC, leading to an increase in US OCC price. Company B Company profile. Company B is a large packaging company headquartered in Qingdao, Shandong province. Currently, it has 11 packaging bases, of which five are in North China, and six are in South China (one base each in Wujiang, Suzhou, Changshu, Hangzhou, Ningbo, and Dongguan). Company B s annual revenue is roughly RMB1bn. Industry overview. The packaging industry is highly fragmented with CR10 at only about 5%. Demand breakdown. E-commerce counts for a high percentage of total demand in South China (eg, at the Wujiang factory, e-commerce represents 30-40% of demand, and food and beverage 40-50%). In North China, this percentage is lower, but still above 20%. Aside from e-commerce and food and beverage, the company s packaging bases in Jiangsu and Zhejiang have many customers in the daily-use chemical industries. Customers from the electronics industry are few because Company B is cautious on the accounts receivable problem associated with the industry. Demand. Growth in demand from e-commerce is fast. In contrast, demand from other industries is stagnant or even declining. 28 September

3 Paper procurement. Paper procurement cost is expected to be up by RMB150/t from June to September for the industry while the upside applying to the company could be lower, for two reasons: 1) packaging companies secured their purchases in advance of the G20 summit; and 2) supply is partially shifting from East China to South China as the RMB /t higher ASP in South China will not be offset by a seaborne transportation cost of RMB60/t. Company B s ASP. Contract sales (usually for negotiated customers with a national presence, and customers who signed a long-term contract with Company B) will be conducted at pre-settled contract price unless a sharp decline in raw paper price occurs, such that customers require a lower price. Spot sales (to customers willing to follow the market trend) will be conducted at market price. Therefore, Company B prefers a mild decrease in the raw paper price most. Outlook on paper procurement price. Price of raw packaging paper may decline in October and November, then rally mildly in December. Outlook on packaging industry. Widespread bankruptcy of packaging companies in 2015 was mainly a result of improper cross-industry operation, which has become rare in After the correction of this unwise strategy, room for future development is still sufficient for the packaging industry because: 1) current 7% GDP growth in China should indicate a 10% growth in packaging demand; and 2) annual packaging paper consumption per capita of USD23 in China is still low, compared to a global average of USD32, and USD300 in the US. Future expansion plan. Based on an optimistic view toward the China packaging industry, Company B plans to build one new packaging factory annually for the next five years. Outlook on packaging paper industry. To cater to the needs of the packaging industry, 4m paper machines (PM) will be superseded by 6m PMs. Lightweight paper products will become the mainstream. Capacity addition in packaging paper. Because of a power-plant problem, only one of the two new production lines at Sun Paper is operating. So far, the production volume of the new lines is not large and the products are mainly sold in North China. Other. The technical upgrade of a PM at New Dragon Paper (NDP, Tianjin) enabled the PM to produce both linerboard and corrugated medium products (only linerboard before upgrade), leading to a supply shortage in corrugated medium in Tianjin. Therefore many of Shandong s corrugated medium products are exported to Tianjin. Company C Company profile. Company C is a leading packaging paper producer in Zhejiang with capacity of 570ktpa after two new production lines with aggregate capacity of 300ktpa were added in July. In recent years, it has generated annual revenue of RMB800mn from its containerboard business and RMB180mn from its packaging business. Company C has its own captive power plants. 28 September

4 ASP and price hike. Company C began hiking the price in June because of the rising cost of OCC and coal. So far, the cumulative magnitude of the increases in transacted price are RMB /t for corrugated medium, and RMB /t for linerboard. Because of the supply cut caused by the G20 summit, this upward trend is still in good shape. Therefore, other nearby paper companies hiked their price recently, and Company C will follow this step to hike its price by another RMB50/t before National Day on 1 October. Generally, Company C s ASP is RMB20-30/t lower than that of NDP. Production cost. Since OCC price slid recently after the RMB200/t price hike at the peak time, Company C s increase in ASP outpaced the increase in raw material cost. Captive power plants also help in reducing cost at Company C. Net dollar margin. Net dollar margin for Company C is RMB100/t based on current ASP and cost, if tax rebate and other allowances are included. However, the margin is slimmer than two years ago. Outlook on 4Q16 paper price. Company C thinks that in 4Q16, paper price in Jiangsu and Zhejiang province will climb, driven by cost pressure and margin contraction. Downstream packaging companies are also hiking their price, which makes the implementation of a price hike in containerboard feasible. Demand. Demand is not robust now, and export demand has declined by 30-50% yoy. Inventory. During the G20 summit, 50% of Company C s capacity was suspended. For some other paper manufacturers, 30% of total capacity was halted during the summit. Therefore, inventory in Zhejiang is at a low level now for the industry. As Company C has always strictly kept inventory at under three days production volume, its inventory level is roughly the same as in Capacity expansion at Company C. Two new corrugated medium PMs at Company C (investment, RMB380mn; capacity, 300ktpa) began production in July. Company C will continue to expand, to achieve scale economies and improve competitiveness. Capacity closure. Because of the high environmental protection cost, more small mills are closing their PMs. Quanlin Paper closed one of its PMs and got a subsidy from the government for doing so. Company D Company profile. Company D is a packaging paper manufacturer in Zhejiang. It has three PMs with total capacity of 180ktpa. Most of its products are g/sqm Level B packaging paper. Demand. Shipment in 2016 is robust and better than that in previous years. Company D is experiencing supply tightness or even supply shortage, for two reasons: 1) supply cut during G20 summit; and 2) increased shipment in South China and Hunan. There s no significant change in demand from regular customers, or large customers in the fruit industry. At the same time, demand from small appliance companies was down by 20% to 30% yoy in The increase in shipment is mainly because of increased purchasing from external retailers. Hikes in ASP. Paper prices declined sharply in March and April, then began to rally in 28 September

5 July. So far, Company D has hiked its ASP six times, with the increase in transacted price differing from customer to customer. Cost. Waste paper used by Company D is solely domestic OCC. Transportation cost of OCC for Company D is roughly RMB40/t and is higher if a bridge is crossed during transportation. Inventory. Inventory declined to 2-3kt (vs kt total stocking capacity) from the high level in March. Capacity. Company D routinely shuts down its PMs for eight hours every month and will have scheduled maintenance at the three PMs from October. Meanwhile, Hualian Paper cancelled its original plan to add a new PM. It is still unclear whether there will be a compulsory production suspension during the upcoming Internet Conference. Outlook on the industry. As 2.2m box becomes more prevalent in the packaging industry, small PMs will become less capable, and only 6m-or-larger PMs will be competitive. Other. Accounts receivable days is decreasing. Company E Company profile. Company E is a packaging paper producer in Zhejiang province. It has one 3.4m PM and one 4.8m PM. Speed of the PMs is 500m (105g)/min, which is good in the industry. Company E s total capacity is 170ktpa. Demand. Demand is solid, and Company E is experiencing some supply shortage. Price hike. Despite the robust demand, Company E s ASP has only increased by RMB50/t, dwarfed by an RMB200/t price hike in OCC. Large companies are pressing home price hikes, but Company E feels it is difficult for small companies to implement a price hike. Company E has also been tracking implementation of the price hike announced by a nearby large producer, and found that the price hike announced by the producer has been poorly carried out. Cost. Electricity cost is roughly 310kWh/tonne (assuming 105g/sqm), while the power tariff is RMB0.78/kWh, more than RMB0.1/kwh higher than that in North China. The price of steam is RMB140/t (versus RMB60-70/t in Shandong province). Capacity. Company E plans to resume production of its previously idled 3.4m PM in late September or early October. Company F Company profile. Company F is a linerboard paper producer located in Fuyang, Zhejiang province with a 5.6m PM and total capacity of roughly 200ktpa. The average weight of its products is 130g/sqm. Currently, Company F has annual waste water emission rights of 85kt, but this is not booked as an asset in the balance sheet as it is compulsory. 28 September

6 Paper industry in Fuyang overview. Most companies in Fuyang are whiteboard producers. In its heyday, there were more than 400 whiteboard producers with total whiteboard capacity of 5mtpa. Fuyang whiteboard production volume at that time accounted for about 65% of the China total. Compared with the industry as a whole, Fuyang s paper industry remains quite fragmented: it currently has roughly 270 paper companies with capacity of ktpa each, and another 150 plus companies with capacity above 100 ktpa each. De-capacity in Fuyang. Fuyang is endeavoring to eliminate excess capacity through multiple methods. First, the government controls total capacity in Fuyang by selling waste water emission rights at a price of RMB150/t. Meanwhile, local government is also consolidating the industry by shutting down or re-structuring small mills with capacity below 30ktpa. So far, four new big consolidated paper companies have been formed through the re-structuring of small mills. The big four can enjoy more favorable tax policies and can have a 3% rebate on local tax. As the new big four are mainly whiteboard producers, Company F was not involved in the re-structuring. Capacity suspension during G20. Company F began its production suspension on 16 August, four days earlier than originally planned (20 August). Hikes in ASP. Paper price failed to climb before June, and transacted price has only inched up by RMB50/t since June, eclipsed by the high price of OCC which has only slid slightly from its peak level this year. The good news is that the G20 summit prompted a thorough inventory destocking, and both large packaging paper producers and downstream packaging companies are hiking their price. These two favorable phenomena will lay a more solid foundation for future price hikes. Production cost. Unit consumption of electricity/steam is 300kWh/1.6t for each tonne of paper produced. With power tariff at RMB0.68/kWh (off-peak) and steam price at RMB100/t, unit costs are roughly RMB204/t for electricity and RMB160/t for steam. Environmental protection cost. Environmental protection cost is roughly RMB10/t, including a monthly expenditure for waste water discharge of RMB1.5mn. Treatment of waste plastic is more difficult, as little waste plastic has been treated yet, despite the help of collaboration partners. Fig.1. Paper sector: valuation comparison Market cap PE (x) PB (x) EV EBITDA (x) Stock name Ticker (USDmn) E 2017E E 2017E E 2017E H shares Lee & Man Paper 2314 HK 4, Nine Dragon Paper 2689 HK 4, Sunshine Paper 2002 HK na na 0.8 na na 6.4 na na Weighted average A shares Chenming-A CH 2, Sun Paper CH 2, Weighted average Global International Paper IP US 19, Stora Enso STERV FH 6, Weighted average Source: Company data, Bloomberg, Huatai HK Research estimates 28 September

7 Fig.2. Paper sector: share performance comparison Market cap Absolute performance (%) 1y relative (%) Stock name Ticker (USDmn) 1d 1w 1m 3m 1y ytd vs Index HSI H shares Nine Dragon Paper 2689 HK 4, Lee & Man Paper 2314 HK 4, (1.4) Chenming-H 1812 HK 1, (1.7) Sunshine Paper 2002 HK (1.3) Weighted average Shanghai Composite 0.6 (0.8) (2.3) 3.5 (3.0) (15.3) A shares Chenming-A CH 2, (0.9) (2.9) (3.3) 37.3 Huatai Paper CH (1.6) (1.6) (14.7) 9.5 Sun Paper CH 2, Bohui Paper CH (0.3) (24.1) 5.1 Shanying CH 2, (0.3) (13.5) (20.8) (10.5) Yueyang CH 1, (2.3) (0.4) 17.6 Weighted average 0.8 (0.8) (5.8) Source: Bloomberg, Huatai HK Research estimates 28 September

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