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3Q22 results in line with our forecast　　Xianhe Co Ltd (Xianhe) announced its 1-3Q22 results: Revenue grew 26% YoY to Rmb5.51bn, and net profit fell 37% YoY to Rmb567mn. In 3Q22, revenue rose 30% YoY to Rmb1.91bn, and net profit fell 28% YoY but rose 2% QoQ to Rmb213mn, in line with our expectation.　　Comments:　　1. On course to see full-year sales volume grow YoY, price trends up quarter by quarter: Thanks to its coverage of multiple product categories, the challenging macroeconomic conditions had limited impact on the firm. As some product categories, such as glassine paper and thermal paper, are seeing robust demand, we expect the firm’s full-year sales volume to increase about 20% YoY. In addition, we estimate that the firm’s ASP trended up quarter by quarter, reaching about Rmb9,600/t in 3Q22, partially offsetting the pressure from rising prices of some raw materials.　　2. Rising costs weigh on profit margin, Kingdecor’s operations come under pressure. According to our calculation, per tonne cost increased about Rmb300 QoQ in 3Q22, mainly due to rising electricity costs and average pulp price. Due to high pulp and titanium dioxide costs, subsidiary Kingdecor’s net profit was only Rmb44mn in 3Q22 (contributing investment return of Rmb22mn), down 73% YoY and 48% QoQ, and becoming a drag on the firm’s net profit. However, considering titanium dioxide price has fallen more than 20% from the elevated levels seen in early-2022 to Rmb15,000/t, and Kingdecor’s sales volume has been recovering QoQ, we are optimistic that the firm’s investment return could recover QoQ in 4Q22.　　3. Government subsidies boost net profit. In 1-3Q22, other revenue increased 100% YoY to Rmb89mn, mainly contributed by government subsidies.　　4. Operating cash flow remains steady. In 1-3Q22, operating cash flow grew 30% YoY to Rmb530mn, with cash flow-to-net profit ratio at 93%. Capex rose to Rmb673mn, mainly due to construction of new bases.　　Trends to watch　　We expect both sales volume and ASP to rise in 4Q22; fuel cost crucial for profit. According to channel checks, the firm has a strong order backlog, and its production capacity utilization rate remains at an elevated level. We are optimistic that the firm could announce price hikes in 4Q22 amid the traditional peak season, driving QoQ growth in both sales volume and ASP. On the cost side, if the newly added hardwood pulp production facilities at Arauco (end-November) and UPM (end-1Q23) with combined capacity of 3.66mnt commence operation, pulp prices may decline moderately from end-2022 to 1H23. However, considering it takes at least one to two quarters to finish ramp-up of new pulp production lines and shipment scheduling, we believe pulp prices could continue to exert pressure on the cost side in 4Q22 on a sequential basis. In addition, considering electricity and gas prices could trend up in 4Q22, the firm’s combined per tonne raw material and energy cost could increase more than Rmb200 QoQ.　　Growth prospects remain positive over the medium term. According to an announcement by the firm, production facilities with annual capacity of about 400,000t (including 300,000t of food packaging cardboard and 100,000t of specialty paper production capacity) could commence operation over 4Q22-1H23, and we expect full year production capacity to increase more than 25% YoY. If pulp price falls as expected, we believe the firm could witness strong earnings growth in 2023. From a mid- to long-term perspective, with the commencement of Xianhe’s forest-pulp-paper integration projects in Hubei and Guangxi in 2024, we project its production capacity could record a CAGR of more than 20% over the mid to long term, and the proportion of self-produced pulp could rise above 50%. We believe output growth could help the firm cement its leadership, and self-produced pulp production facilities could help it strengthen control over raw material quality and expand the firm’s cost advantage, driving up average profit margin.　　Financials and valuation　　Given cost pressure from energy and raw material prices in 4Q22, we lower our 2022 and 2023 net profit forecasts 9% and 9% to Rmb819mn and Rmb1.21bn. The stock is trading at 20x 2022e and 14x 2023e P/E. We roll over valuation to 2023 and maintain OUTPERFORM rating and our TP of Rmb35 (implying 20x 2023e P/E), offering 50% upside.　　Risks　　Larger-than-expected fluctuations in pulp and energy prices and/or launch of new capacity; downstream demand disappoints.【免责声明】本文仅代表第三方观点，不代表和讯网立场。投资者据此操作，风险请自担。