The market is suddenly concerned about overcapacity issue of tissue paper industry in China that is expected to lead to a price war. In addition, sales volume growth of tissue paper manufacturers could be weaker than forecasted previously. As such, share price of Vinda (03331 HK), Hengan (01044 HK) and C&S (002511 CH) fell by 9.9%, 3.1% and 2.4% today, respectively.
Tissue paper consumption has kept growing in China on rising per capita consumption. China tissue paper market structure is somewhere in between perfect competition and oligopoly. In addition, the top 4 players accounted for only about 30% of market share, which motivates aggressive capacity expansion of existing players as well as attracts new players. As shown in table-1 below, CAGR of tissue paper production capacity of Hengan, APP and Vinda are expected to be roughly 25% during 2011-2014, which is estimated to surpass demand growth for the same period. We expect industry consolidation to speed up on overcapacity issue. Leveraging on economies of scale, large players will survive. In addition, the rising urbanisation rate in China will boost wood pulp tissue paper demand and the non-wood pulp tissue paper market is expected to keep contracting. We do not believe new players, which lack the experience in producing household products and have not established extensive retail sales networks, to post huge threats to big players. To conclude, weighted average utilisation rate of major tissue paper players is expected to remain high but we did factor in a mild decrease in utilisation rate of tissue paper business of Vinda and Hengan in 2013-2014 as compared to that in 2012.
In 1H12, both ASP (RMB) of Vinda (down 1.4% YoY or 0.1% HoH) and Hengan’s tissue paper business suffered, despite product mix improvement, which was mainly attributable to discounts given to consumers on low pulp price to promote their brands. Huge promotion discounts of selective household products at supermarkets and hypermarkets offered to consumers are not new practice of marketing campaign and ASP of Vinda and Hengan tissue paper business is not expected to decrease significantly in 2013, despite possible deterioration of product mix.
Pulp price continues to stay low, which favours gross margin to remain at reasonable level, despite an expectation of a mild decrease in ASP. Average foreign short and long fibre pulp prices dropped by 7.1% and 20.6% YoY in 3Q12, respectively, or 0.6% and 6.8% lower than the corresponding prices in 2Q12 (Figure-1 and Figure-2). World pulp inventory days remained high at 38 days in July on weak demand in the US and EU. With respect to slow economic growth recovery expectation, strong demand in China is not expected to push up pulp price significantly.
Although market sentiment towards household products sector could remain weak in the short run, we are positive on the long term growth prospect of large players, especially Vinda. Current valuation of Vinda is attractive (18.6x 2012 PER and 15.1x 2013 PER) and we have “Accumulate” investment rating on the Company with a TP of HK$13.5. On the other hand, valuation is just fair for Hengan (26.0x 2012 PER and 21.7x 2013 PER) and we are “Neutral” on the Company with a TP of HK$85.0.