Hengan eyes new boost from adult nappies as its growth stalls

The hygiene products maker has underperformed the Hang Seng Index this year and is relatively undervalued, leaving room for a rebound of its shares

Key Takeaways:

• Hengan’s revenue fell in the first half of the year, but an improving gross margin helped to lift its profit by nearly 15% 
• The company faces intense competition in its core tissue and sanitary napkin businesses, but its disposable diapers segment could benefit from the graying of China

By Bai Xinrui

It’s not easy being in hygiene. At least that’s the case in increasingly cost-conscious China these days, where retail sales of daily-use items grew just 2.3% in the first half of the year, trailing 3.7% growth for all consumer goods, due to fierce competition in the personal care market.

Leading hygiene products manufacturer Hengan International Group Co. Ltd. (1044.HK) wasn’t immune from the challenges, reporting a year-on-year revenue decline for the six-month period, according to its latest interim results released earlier this month. But the company’s relatively sound report – including profit growth – also made it an outlier in its field as one of China’s top sellers of tissue, sanitary napkins and disposable diapers. 

Hengan’s latest results show its profit rose 15% year-on-year to 1.41 billion yuan ($200 million) in the first half of 2024, as it left its interim dividend unchanged at 0.7 yuan per share. But its revenue fell 3% during the period to 11.84 billion yuan. Revenue for its core tissue paper business, accounting for more than half of its total, fell 3.1% during the period to 6.95 billion yuan. Revenue from its second-biggest product line of sanitary napkins also fell 2.2% year-on-year to 3.15 billion yuan.

Falling raw material costs 

Despite the revenue decline, Hengan was able to boost its profit thanks to a higher gross margin. CFO Li Wai Leung explained that a sharp decline in raw material prices in the second half of 2023 lightened the company’s cost load in the first half of this year. That, coupled with improvements to its product mix, including greater focus on high-end products, helped the company to raise its gross margin in the first half of the year by 2.3 percentage points to 33.3%. Here, we should also note that the latest gross margin was still 3.25 percentage points lower than the second half of 2023, showing there’s still room for improvement this year.

Leung said the price of wood pulp has already started to rebound from previous lows, and the company will try to stabilize its margin in the second half of the year by continuing to focus on more profitable higher-end products. 

Major investment banks are closely monitoring the company’s gross margin and the state of intense industry competition. Some even lowered their target prices for Hengan’s stock, which may have contributed to a 6.5% decline in the shares the day after it released its latest financial report, making it the worst-performing blue-chip stock that day. 

Among investment banks, Daiwa has expressed concerns about the company’s gross margin and predicted that falling prices for tissue products due to fierce competition will further pressure that metric. Accordingly, it cut its rating on Hengan from “outperform” to “hold,” and reduced its target price by 16.7% from HK$30 to HK$25.

Citi believes that the company’s interim results fell short of market expectation, mostly due to the oversupply of tissue paper and sanitary napkin products in China that led to intense competition and price cuts. The bank worries that the pressure will grow on Hengan in the third quarter and adjusted its target price down slightly from HK$25.40 to HK$25 while maintaining its “neutral” rating.

Business models are inevitably changing in the new retail era, leading Hengan to boost investment in its e-commerce business. While its overall revenue fell, revenue from Hengan’s e-commerce and new retail channels grew 6.5% year-on-year to 3.76 billion yuan in the first half of the year. That lifted those newer retail channels to 31.8% of total sales for the period, up 2.8 percentage points year-on-year. Hengan expects the share of sales over new retail channels to further increase and will also continue to tap that demand by rolling out new outlets on e-commerce platforms like Douyin, the Chinese edition of TikTok. 

Future in disposable diapers 

To further diversify, Hengan has begun tapping into the disposable diapers business, which currently accounts for just 6% of its revenue. While sales for its core tissue paper and sanitary napkin businesses fell in the first half of the year, disposable diaper sales bucked that trend by growing 7% year-on-year to 710 million yuan, as its products gained market share.

Hengan pointed out that in addition to benefitting from better brand recognition for its baby products, the disposable diaper business also stands to gain from new demand for adult disposable diapers as China’s rapidly aging population faces issues like incontinence. 

As the population ages, the number of people in China above 60 is expected to pass 300 million by 2025, or more than a fifth of the country’s 1.4 billion population. The group is expected to grow further still to about 400 million by 2035, exceeding 30% of the population. Such a rapidly growing senior population will almost inevitably bring a major new business opportunity for Hengan’s adult disposable diaper business.

The hygienic products market is likely to face headwinds from fierce competition in the next few years, though Hengan could offset some of that if it can tap into new demand for adult disposable diapers. According to Bloomberg data, Hengan’s profit per share is expected to rise 5.7% this year and 5.2% in 2025 to 2.55 yuan and 2.69 yuan, respectively. Its gross margin is expected to reach 33.7% over that time, which is still lower than its peak of 42.3% in 2020.

Moreover, the dual challenges of rebounding wood pulp prices and rising competition have made Hengan’s stock an underperformer this year. The company’s shares are currently down about 18% year-to-date, trailing a 3.8% gain for the broader Hang Seng Index.

Following its price declines, Hengan’s stock now trades at a forward price-to-earnings (P/E) ratio of just 8.5 times, with a forecast dividend yield of 6.5%. Such figures indicate the downside risks facing the company have already been priced into its stock. For the shares to rally, the company will need to show continuing recovery in its gross margin. And more upbeat news from its disposable diaper business would also probably help.

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