Revenue and profit have surged in the past three years on the back of Beijing’s policies, with listing crucial to expansion plan across China

Key takeaways:

  • China Treasures New Materials, the biggest producer of biodegradable plastics in northeastern China, has applied for a Hong Kong IPO to raise cash to expand production capacity
  • Plastics ban by the Chinese government means traditional plastics bags must be replaced with biodegradable alternatives, which has produced a windfall for the company

By Tina Yip

One of the world’s toughest bans on plastics introduced by Beijing in 2020 with the aim of eliminating non-biodegradable bags has resulted in giant dividends for China Treasures New Materials Group Ltd., which is looking to take this boon to the bank and has applied for a listing in Hong Kong.

Headquartered in northeastern Changchun, China Treasures New Materials has reaped huge rewards from the ban, which has given a considerable boost to its revenues and profits.

And with the wind in its biodegradable sails, the company filed for an IPO on the Hong Kong Stock Exchange last Tuesday with the goal of raising enough money to expand its production capacity in order to take its operations nationwide.

Already the biggest producer of biodegradable-plastic products in northeastern China, the company was established in March 2014 and started out producing non-biodegradable plastic vehicle parts.

One year later the management team made an important decision to shift focus to the manufacturing of biodegradable-plastic products including roll-up bags, shopping bags, package wrapping and master batches, which combine colors and other additives to create the final product.

The shift coincided with the government’s decision to step up environmental protection efforts by targeting so-called “white pollution” caused by plastics. And, following China’s broad ban on the use of plastics, in recent years the government has started to encourage the use of biodegradable alternatives across the country.

Soaring raw material prices

China’s demand for biodegradable plastics has spiked due to these new policies. According to its prospectus, China Treasures New Material’s revenue surged from 103 million yuan ($15.4 million) in 2019 to 257 million yuan last year, an increase of 150%, more than 90% of which came from the production of biodegradable plastics. Its annual profit almost tripled from 27.14 million yuan to 78.42 million yuan during the same period.

Biodegradable plastics can react with germs, organisms and microbes and degrade over time, unlike traditional plastics that will stay permanently in a landfill. But the raw material costs of the new plastics have consistently risen over recent years.

According to its prospectus, the company said one particular material called polylactic acid (PLA) saw its price grow by 6.6% at an annual compound rate from 2016 to 2020 and another called polybutylene adipate terephthalate (PBAT) by 5.2% during the same period. As a result, raw material costs have taken up 87.2% of the company’s total costs, putting pressure on its operations.

It has also cited the lack of control over the price and availability of raw materials as a risk factor to its operations, which makes its performance susceptible to price volatility. Also, five of its suppliers accounted for more than 80% of the value of its material procurements in the past three years, which is obviously unhealthy.

But the company has higher gross margins than the biodegradable-plastics producer Kingfa Sci & Tech (600143.SH), which boasts a nationwide operation and margins of 40.5% to 44.1% versus the latter’s 33.9%, which speaks to the company’s great capacity to generate profits.

High margins and profits owe a great deal to the company’s effectiveness in controlling costs. Astoundingly, the company claims it has only three salespersons among 156 employees and its sales and distribution expenses in the past three years were only 1.14 million yuan, 894,000 yuan and 1.41 million yuan, respectively. Despite this, its sales continued to grow.

Repeat clients

Part of the reason why it has kept costs low is due to sufficient demand for its products as a viable alternative to traditional plastics. Moreover, it is very much dependent on five major clients who contributed more than 50% of its revenue in the past two years. Repeat customers also accounted for more than 94% of its revenue, with this revenue setup diminishing its incentive to tap new customer sources and limit its distribution expenses.

But both of these policies and a concentrated client base can cut both ways. Favorable policy signals have fueled competition in the sector and repeat customers can easily be lost to competitors. Indeed, this presents a risk of losing major clients, which can deal a fatal blow to its business.

Of course, China Treasures New Materials will not just sit back and do nothing. Indeed, it is eager to go public, raise money, and expand capacity so that it can establish a nationwide presence.

It intends to use the funds to expand its production in Changchun and build a new production base in Huizhou in southern Guangdong province. Once completed, the base in Changchun will triple its annual master batch production to 45,900 tons and the facility in Huizhou will churn out 17,500 tons per year to meet the rising demand for biodegradable plastics in China.

The government’s policy windfall has attracted a large number of companies to join the fray. Public companies are also adding new production lines, including Henan Jindan Lactic Acid Technology (300829.SZ), Red Avenue New Materials (603650.SH), Wanhua Chemical (600309.SH) and Shandong Ruifeng Chemical (300243.SZ). Clearly there is no shortage of competition and things are heating up.

In addition, many latecomers have successfully cultivated strong distribution networks outside Northeastern China, where China Treasures New Materialsis still is the biggest. Price wars with competitors to secure more market share across China is inevitable.

How much it will appeal to investors will depend on its IPO valuation, which is estimated at around 1.41 billion yuan given the price-to-earnings (P/E) ratio, a big ask given it would make it 18-times larger than Kingfa Sci & Tech.

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