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China Paper Holdings Limited
April 21, 2007, 2:24 pm
Filed under: companies analysis

China Paper Holdings Limited (SGX: C71)

Price Information (as of 20 April 2007):

52 Week High: 0.45

52 Week Low: 0.260

Earnings per Share: 0.34RMB = 0.068 SGD

P/E Ratio: 4.485

Company Profile

Established in Linyi City, Shandong Province, the PRC, China Paper Holdings Limited has a vertically integrated paper manufacturing operation equipped with in-house production facilities for the manufacture of wheat pulp, paper products and paper chemical products. The Group’s core business is in the manufacture and distribution of mixed-pulp based paper products made from a mixture of wood pulp and wheat pulp. Its close proximity to an abundance of wheat straw farms in Shandong Province ensures ready access to good quality wheat straw, which in turn boosts cost, logistical and operational efficiencies.

The Group’s products are sold to over 320 customers comprising publishing houses, printing companies and other paper distributors throughout the PRC. It has an extensive sales and marketing network in regions with high paper consumption like Beijing, Shanghai, Jiangsu and Zhejiang. Its range of paper products, includes uncoated printing paper, lightweight packing paper, newsprint paper and semi-finished toilet paper. China Paper also sells paper chemical products such as sodium hydroxide and liquid chlorine.

Analysis

China Paper offers an earnings yield of 22.3% which is pretty high and it trades at a P/E ratio of a mere 4.485. First question is why investors value it so lowly?

A comparison across the years reveal certain aspects of the business. Revenues have increased by 18.8% in 2006, 8.366% in 2005, 8.848% in 2004 and 45.67% in 2003. Hence revenue increases seems to be erratic, which is not a great sign since China Paper is selling what is essentially a commodity. However a counterpoint would be that net profit margin stands at 17% for 2006, a decrease from 21% in 2005. The existence of a pretty decent profit margin seems to suggest that competition within the industry has not peaked yet, leaving room for China Paper to expand operations.

However, the surprising thing is China Paper has spent nothing on capital expenditure and there are no indication of plans to increase production capacity through building new factories or buying more machines. It is operating at almost full capacity at 168 tonnes of 180 tonnes and give the annual report’s statement that the paper industry is going to grow 10% in 2007, it is surprising why China Paper has no expressed intentions to increase production capacity to capture this growth. Is it because they do not think that they are able to increase sales? Or is it because they are switching production to products with higher profit margins?

On top of this lack of capital expenditure, the Chinese government’s increased emphasis on environmental protection and its imposition of regulatory measures on industry has forced China Paper to invest money in waste water treatment facilities at an expected cost of more than RMB 80m. This will go to severely supress future profits and cash flow; net profits for FY 2006 stands at RMB 135.5m and the cost of the facilities represent more than half of net profits in terms of proportion.

That said, China Paper is sold on paper. Current ratio is 2.33 for 2006, net profit margin is 17%, ROE is 44.4%. The problem is that there is no upward trend over the years for all main indicators, like net profit margin, ROE and EPS. Another burning question is why no dividends are proposed for FY 2006, despite a high EPS and decent cash flow. Maybe the company is planning to pay for the new waste water treatment facilities or to ride out tough times ahead.

The overaching economic and political framework that this business operates in is largely a inconducive one. The Chinese goverment’s drive for eco-friendly industry has also made China Paper build a waste water plant to reach regulatory standards. The US has recently imposed heavy tariffs on Chinese high gloss paper; although China Paper does not produce this kind of paper, China Paper will have at least lost one potential avenue for expansion and the US government might even imposed tariffs on other kinds of Chinese paper in the future. That said, the Chinese demand for paper should grow as China modernises. China Paper operates out of Shandong and it makes procuring raw materials easier since Shandong is a major agricultural production centre.

A thought: if the Chinese paper industry is projected to grow by 10% in 2007, China Paper ought to increase its revenue by more than 10%, since its a rough indicator that it is expanding its market share and not just feeding off the overall growth in paper demand.

For

  • High earnings yield, low P/E, simple business, decent EPS

  • High conversion rate of cashflow per share to earnings per share

  • High ROE

  • Solid balance sheet with no debt

  • Chinese paper industry should grow over the next few years in tandem with Chinese economic growth

Against

  • EPS and net income decreased in 2006 from 2005

  • Cash position decreased in 2006 from 2005

  • No indicated plans to increase production even though company is almost at full production capacity, which might be a signal of management lacking confidence.

  • The need to comply with environmental regulations is bad for the profit line.

  • Hard to see any sustainable competitive advantage, coupled with the fact that paper is pretty much a commodity.

Watch out for

  • Plans to expand sales overseas

  • Impact of investment in waste water plant

  • Ability to obtain cheaper wood pulp

  • Differentiation of products and brand building

  • Ability to increase market share and costumer base

Links

http://www.nytimes.com/2007/03/31/business/31trade.html?ex=1177300800&en=01dfa2e742153ffb&ei=5070

Disclaimer: The author bears no responsibility for any financial losses caused by reliance on the author’s views. Investors are advised to do their own research before making their investment decisions.

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