Golden Hair Tech: Irreversible Predicament?

On November 24, Jinhai Technology made headlines by announcing a significant investment of 500 million yuan from Jinshi Fund into its subsidiary, Te Su Company. This marks the largest capital increase received by the company’s new materials division in recent years, indicating a strategic move to bolster its financing capabilities.

However, for a group that finds itself under the immense pressure of tight cash flow and high debt levels, the impact of such investment appears almost insignificant. Furthermore, the company’s core business in modified plastics is currently struggling in a prolonged downturn, making the prospect of a swift recovery seem increasingly challenging.

Jinhai Technology operates primarily in the modified plastics sector, which contributes about 60% of its total revenue. Modified plastics enhance standard plastics through various processing techniques, improving their flame resistance, strength, toughness, and impact resistance. These materials have applications across multiple industries, including home appliances, automotive, electronics, and construction.

The company also diversifies its offerings with ventures in green petrochemicals, material trading, new material products, and healthcare. Despite stable growth in revenue over the past several years, net profit has been less than satisfactory, with an apparent negative correlation to fluctuations in raw material prices. In 2023, the net profit attributable to the parent company plummeted by 84% to 317 million yuan, reaching the lowest level since 2010.

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While the first three quarters of 2024 saw a rebound with net profits surging to 683 million yuan—up 41% year-on-year—this growth is largely misleading. It stems from a comparison with a low base from the previous year; the absolute figure still lags significantly behind the profits recorded in any year from 2019 to 2022.

Sustained deterioration in profitability is evident as well. By the end of Q3 2024, the gross margin had dropped to 12.22%, marking a record low for this period since 2006, not accounting for the pandemic-induced spikes in healthcare. The latest net profit margin stands at a meager 0.79%, the lowest since financial disclosures began in 2003. This decline is closely tied to the long-term fall in the pricing benchmarks for modified plastics manufactured by Jinhai Technology.

Adding to its woes, Jinhai Technology faces mounting cash flow constraints and declining debt repayment capabilities. The company recently reported an alarming asset-liability ratio of 68.9%, its highest since going public. In comparison, competitors like Wanhua Chemical and LUXI Chemical maintain lower ratios of 67.19% and 48.75%, respectively. This predicament is attributed to the aggressive borrowing undertaken by Jinhai in recent years, coinciding with a downturn in the modified plastics market.

In summary, Jinhai Technology's long-term performance is lackluster, marked by deteriorating profitability, soaring debt levels, and an overall operational crisis.

To assess Jinhai Technology’s medium to long-term growth potential, it is necessary to analyze two critical dimensions: volume and price.

According to the Qianzhan Industry Research Institute, China produced approximately 11.9 million tons of primary plastic in 2023, reflecting a growth rate of 6.3%. Using a modified plastic conversion rate of 25%, this means China’s modified plastic production was around 3 million tons, with Jinhai holding a roughly 7% market share, trailing behind Guo'en Co., which commands about 3% and positions itself among the top two in the domestic market.

Market analysts expect the production and sales of modified plastics in China to rise due to emerging sectors such as new energy vehicles, artificial intelligence, and the Internet of Things. This optimism is based on the belief that established players will continue to gain strength, thereby capturing an even larger market share.

However, the logic predicating Jinhai's market share increases does not appear very reliable upon reviewing over a decade of its development. As per statistics by ussrPaul, the peak market share of Jinhai’s modified plastics occurred in 2014, exceeding 9%, but has since seen a downward trend, landing at approximately 7% in 2023.

It is clear that Jinhai is planning for an expansion in both production and sales volume. The firm's "333 Strategy" aims for 300,000 tons in sales, a 30% contribution from engineering plastics, and 30% of sales from Fortune Global 500 clients. Yet, with 2023 figures showing only 215,000 tons of modified plastics produced, the company has considerable ground to cover to meet these ambitious targets.

From a pricing perspective, while there are no authoritative national figures for the prices of modified plastics, the Producer Price Index (PPI) for the plastics industry somewhat reflects the overall price trends. As of June 2023, the PPI for the plastics industry plummeted to 94.5, the lowest in several years and slightly above the trough of 2009, substantially lower than the cyclical low points seen in 2015 and 2020. While there has been a small recovery since then, the PPI still remains at historically low levels.

For Jinhai Technology, ussrPaul's analysis indicates that the average price of modified plastics calculated as revenue per volume was 12,765 yuan per ton in 2023—the lowest since 2009 and down 30% from its peak over 18,000 yuan per ton in 2011. This phenomenon of “increased revenue without increased profit” emerges as a central concern affecting the company's viability.

What, then, has driven the cyclical downturn in prices for modified plastics at Jinhai Technology?

Market observations indicate the primary reason lies in the rather low barriers to entry and intense competition within the modified plastics industry. When profitability spikes, numerous firms expand capacity, eventually leading to oversupply and downward price pressure, a pattern evidenced historically in 2009, 2015, 2020, and again in 2023.

The number of modified plastic manufacturers in China has surpassed 3,000; however, only 70 firms possess capacity exceeding 3,000 tons, resulting in a fragmented market structure. This fragmentation is influenced by the low entry barriers, coupled with the widespread and diverse applications across downstream industries.

Additionally, the high-end modified plastics market is primarily dominated by foreign multinational corporations that outpace domestic players in terms of formula development, manufacturing capabilities, and branding strength. Conversely, domestic manufacturers have found themselves embroiled in intense competition primarily within the mid- to low-end markets, further contributing to the downward spiral of prices.

Overall, Jinhai Technology’s current strategy of prioritizing volume increases while neglecting pricing integrity reveals systematic flaws, suggesting weak future profit growth prospects for the company amid its challenges.

Since 2019, Jinhai Technology has sought to extend its reach upstream through mergers and acquisitions, enhancing the production capacities of primary materials such as PDH and ABS. Notably, in May 2019, the company acquired Ningbo Haiyue in its entirety, which was subsequently renamed Ningbo Jinhai. By mid-2024, its annual production capacity comprises 1.2 million tons of PDH, 600,000 tons of isooctane, 800,000 tons of polypropylene (PP), and 400,000 tons of modified PP.

From 2021 to 2022, the company took control of Liaoning Baolai New Materials, rebranding it as Liaoning Jinhai. By the end of 2022, the annual production capacity had reached 600,000 tons of PDH, 600,000 tons of ABS, 260,000 tons of acrylonitrile, and 100,000 tons of MMA.

Jinhai Technology believed that tapping into the upstream materials would ensure raw material supply security and uncover new growth avenues. However, this lofty ambition has ironically transformed into a significant liability for the core business.

From 2020 to 2023, the gross margins for its green petrochemical business plummeted from 14.6% to -12.44%, resulting in losses from 700 million yuan to -1.16 billion yuan. By the first half of 2024, gross losses continued, reaching 290 million yuan. In contrast, rivals such as LUXI Chemical and Satellite Petrochemical maintained positive gross margins.

Evidently, the dismal performance of Jinhai’s petrochemical segment is not solely attributable to prevailing market conditions; it ties directly to internal operational inefficiencies, transcending simple capacity scaling challenges.

Presently, numerous plastic raw materials, including ABS, face oversupply, with more new capacities set to come online, intensifying competition. The overall difficulty of entering upstream raw material markets indicates that this line of business may not prove beneficial; some analysts speculate that Jinhai’s acquisitions of its two petrochemical subsidiaries represent a “strategic misjudgment.”

Turning to the healthcare sector, Jinhai Technology initially enjoyed a wave of growth. In 2020, it ventured into healthcare markets, launching products like melt-blown fabrics, masks, and nitrile gloves, raking in gross profits that surged to 2.06 billion yuan with an impressive gross margin of 76%, propelling company-wide net profits up by 268.6%.

Yet, following this initial boom, the prices of healthcare-related products plummeted, leading to negative gross margins. Revenue in this field contracted sharply from 2.71 billion yuan to just 160 million yuan by the first half of 2024, with cumulative losses hitting around 200 million yuan since 2023.

During the third quarter earnings call, investors posed critical questions about how to avoid ongoing losses, suggesting a potential sale of the healthcare segment. Jinhai’s management responded that their foray into the medical field, crucial for its polymer materials, is essential for achieving the integration of the upstream and downstream value chain, insisting there are currently no plans to divest this sector.

To many investors, this reasoning appears unconvincing since the applications for modified plastics widely span home appliances, automobiles, and healthcare. Some perceive the healthcare move as an impulsive, profit-seeking venture rather than a considered strategy for market diversification.

Jinhai’s ambition to integrate its industrial chain was aimed at reducing production costs while enhancing profitability. Still, recent years suggest that the reality has diverged significantly from those objectives, even becoming a potential hindrance to its primary operations. Overall, given its current “headwind” context, Jinhai Technology seems unlikely to reverse its fortunes, as the era of high growth appears to be a relic of the past.