Source: Zhitong Finance

“Industry rotation” has clearly accelerated this year, and popular concepts such as AI, intelligent driving, and low-altitude economy have rebounded, while Hong Kong stocks, driven by Hong Kong Stock Connect capital, have basically converged with mainland China. The Hong Kong A-share papermaking sector has been trending upward for four months. Recently, there have been significant gains. Among them, Hong Kong stocks Nine Dragons Paper (02689) and Sunshine Paper (02002) have both risen by more than 15% in the past two weeks, leading the sector.

In fact, the valuation of the Hong Kong stock paper sector has seriously retracted. Since March 2021, the index has fallen by more than 70%, and the sector's PB valuation has broken down. This is mainly due to market weakness and investment concerns about the industry's high debt. Furthermore, price fluctuations in the industrial chain have also interfered. However, high-performing stocks in the sector also fell into the “golden pit” as valuations declined. Among them, Nine Dragons Paper led the Hong Kong paper sector, and PB was only 0.34 times higher.

The bottom rebound in the paper sector this year has attracted the attention of right-wing and trending investment capital. So, where are the investment opportunities in the paper sector?

Industrial prices are divided, but the industry is still recovering

The paper industry is undergoing cyclical adjustments. In 2023, downstream inventories were high and demand was weak, and industry performance was under pressure, leading to a continuous decline in revenue and loss of profits for some companies. Pulp prices have risen this year, and the cost side is once again under pressure, but the downstream boom has picked up, and the bottom of the industry cycle may be hidden. According to the data, pulp prices have rebounded for two consecutive quarters, with a recovery of more than 10%.

However, industrial prices are divided, and upstream prices continue to rebound, while downstream reactions have been slow, and prices of various types of paper products are still falling. According to data from the Business Association, during the three-month period from the beginning of February to the beginning of May this year, the white cardboard index, the waste paper index, and the corrugated paper index fell by 11.5%, 3.6%, 3.3%, and 3.6% respectively, while the broad-leaved wood pulp and softwood pulp indices increased by 14.8% and 10.3% respectively.

In fact, the core reason for differentiation is the impact of the inventory cycle. Based on changes in inventory and demand, the inventory cycle can be divided into four stages: active storage removal - active storage - passive inventory replenishment. Each link in the paper industry chain will be different in the inventory cycle, and the downstream cycle will be relatively delayed, because it is necessary to reflect not only last week's inventory but also terminal demand. Under weak terminal demand, upstream prices are difficult to transfer to terminals. It can be seen that at present, the downstream is still in the passive inventory removal stage, but the overall boom in the industry is showing a recovery.

Consumption recovered steadily in 2024, the conflict between supply and demand for cultural paper and household paper was eased, and the recovery in prosperity gradually eased market concerns about industry profits. On the one hand, the industry may enter the active inventory replenishment stage in the second half of the year. This side reflects the rise in paper prices and transfers the risk of upstream price fluctuations; on the other hand, the leading echelons of the industry, including Nine Dragons Paper and Sunshine Paper, are all building integrated pulp and paper strategies to control supply chain costs. Downstream recovery can greatly enhance enterprise growth and profitability.

The concentration of the paper industry is high. Under the integrated pulp strategy of leading enterprises, the profitability of the industry remains stable. In 2023, the revenue of paper and paper products enterprises above the national scale was 1.4 trillion yuan, down 2.4% year on year, but total profit was 50.84 billion yuan, up 4.4% year on year. From a quarterly perspective, industry profits began to be optimized in Q3 last year. In Q1 this year, strong pulp put pressure on the cost side, and profitability was narrower than last year's Q4. Based on expectations of a rebound in paper prices in Q2 and the second half of the year, the performance is relatively optimistic, which will also greatly improve the investment environment in the industry.

However, the performance differentiation of industry targets has accelerated. Targets with a complete industrial chain and high operating efficiency are less sensitive to price fluctuations, and their performance resilience is prominent.

High quality leading companies expand production capacity, and lightning protection targets high debt targets

The Zhitong Finance App learned that both Hong Kong stocks and A-share papermaking groups disclosed their 2023 annual results. Since Hong Kong stocks were not required to disclose quarterly reports, they were not disclosed in Q1 2024. Looking at the performance cycle, in 2021-2022, A-share paper companies all achieved continuous revenue growth, but Hong Kong stocks diverged in 2022. Nine Dragons, Chen Ming, and Lee Man all recorded declines. In 2023, they recorded another double-digit decline, and some companies experienced huge losses.

In contrast, A-share paper's performance is more resilient. Among them, Wuzhou Special Paper's performance was the most impressive. The compound revenue growth rate from 2021 to 2023 was over 35%, and continued to grow by 37.17% in Q1 in 2024, leading the way. Furthermore, as an AH share, Chenming Paper achieved growth in Q1 revenue and turned a loss into a profit. Nine Dragons and Liwen are expected to maintain the same growth rate, which also shows that the industry as a whole is still recovering.

Even in different markets, the performance of Hong Kong A shares is clearly divided, and the performance of Hong Kong Stock Nine Dragons Paper is clearly better than that of other participants in the same market. The company's main products include wrapping paper, cultural paper, and specialty paper, with wrapping paper accounting for up to 92%. Appropriate wrapping paper is leading the business. The business achieved reverse industry growth in 2023. Chenming Paper mainly deals in white cardboard, electrostatic paper, coated paper, etc. Sunshine Paper mainly deals in kraft paper, corrugated paper, and special paper. The performance contribution of each type of paper is quite balanced, not as concentrated as that of Nine Dragons.

Nine Dragons Paper has accelerated its pulp integration strategy, and the steady expansion of production capacity has brought profit expectations. According to the disclosure, by the end of 2023, the company's total design capacity of paper production was 2112 million tons, and the total annual design capacity of the downstream packaging plant exceeded 2.8 billion square meters, actively promoting multiple production capacity expansions. Among them, after implementation of the project, the total design capacity of paper manufacturing will reach 23.67 million tons, and the total design capacity of fiber raw materials will reach 7.04 million tons per year.

It is worth mentioning that Wuzhou Special Paper is also mainly engaged in wrapping paper. It is a leading food wrapping paper, and its past performance has been strong compared to other similar market targets. The company has also adopted an integrated pulp and paper strategy. In 2023, 12 production lines have been built, with a total design capacity of 1.416 million tons. 4 additional paper production lines at the Hubei base and 1 paper production line at the Jiangxi base are under continuous construction in 24 years. It is expected that the raw paper production capacity of more than 2 million tons will be formed in 2024. The steady expansion of production by Nine Dragons and Wuzhou shows that the recovery in demand for specialty paper is far higher than in other sectors, while also bringing more room for sustained high growth.

Major investment banks are very appreciative of the performance of these two companies. According to the Guotai Junan Research Report, the bottom of the industry cycle is gradually recovering upward. As a large-scale industry leader, Nine Dragons Paper has an in-depth forward-looking layout of raw materials, products, and channels, combined with optimization of external supply and demand patterns, and profit flexibility can be expected. Fangzheng Securities Research Report believes that the gradual expansion of production capacity in Wuzhou Special Paper is progressing steadily, and new production capacity continues to be released.

It is worth noting that the paper industry operates as a heavy asset, and the debt ratio is generally high. Many targets face debt crises and avoid stepping on lightning. The most typical example is Chenming Paper. In Q1 2024, the company's balance ratio was 74%, of which short-term bank loans reached 34.157 billion yuan, accounting for 42.6% of total assets, 2.58 times the cash on its accounts. The company actively adjusted its business strategy, divested its non-main business, focused on the development of the main pulp and paper industry, and controlled the expansion of the debt scale. However, HKK2 has filed multiple winding-up petitions against the company, which poses a high risk.

The bottom of the valuation or revaluation. You can pay attention to leading and performing stocks

High-quality companies pay dividends every year to return shareholders. For example, Nine Dragons Paper has paid dividends every year. According to Oriental Choice data, the cumulative dividend has been 32 times since 2006, with a cumulative dividend of 15.465 billion yuan, with a dividend ratio of 17.66%. Although Liwen Paper's performance is slightly poor, the dividends are not stingy. Since 2012, they have accumulated 23 dividends, with a cumulative dividend of 11.22 billion yuan, with a dividend ratio of 22.96%. Also, Chenming Paper has not paid dividends since 2020.

In A-shares, Sun Paper, Bohui Paper, and Wuzhou Special Paper are all high-performing stocks, and they pay dividends every year. In 2023, the dividends per share were 0.3 yuan, 0.03 yuan, and 0.22 yuan, respectively, with dividends of 2%, 0.5%, and 1.4%, respectively.

In terms of valuation, the Hong Kong stock papermaking sector has basically broken down. The valuation of Nine Dragons Paper is attractive as the leading sector. The A-share valuation is slightly better than that of Hong Kong stocks. The PB value of the sector is 1.2 times, and Sun, Bohui, and Wuzhou are 1.6 times, 1.2 times, and 2.6 times respectively. Obviously, with excellent performance, the market has given a higher valuation level. However, higher valuations than peers do not mean that the risk is high; on the contrary, valuations are stronger after resonating with performance.

Overall, the paper industry sector's valuation bottom is obvious, and cyclical adjustments may be coming to an end. As industry performance recovers, the sector will also usher in opportunities for a cyclical rebound, while under sector rotation, individual stock valuations will be revalued. We can focus on Nine Dragons Paper, a leader in the Hong Kong stock paper sector, as well as two high-performing stocks, A-share Sun Paper and Wuzhou Special Paper.