FY23 results miss as weak demand misses expectation
　　Nine Dragons Paper (NDP) announced its FY23 (year ends in June 30, 2023) results: Revenue was Rmb56.7bn (down 12% YoY) and attributable net loss was Rmb2.4bn (vs. attributable net profit of Rmb3.3bn in FY22).In 2HFY23, revenue reached Rmb25.5bn and attributable net loss totaled Rmb995mn (vs. losses of Rmb1.4bn in 1HFY23 and net profit of Rmb501mn in 2HFY22). Our comments are as follows:
　　Output of containerboard and corrugated medium rose steadily thanks to rising pulp and paper production capacity. In FY23, the　firm's sales volume was about 16.6mnt (up 3.4% YoY). We estimate that the sales volume of containerboard, corrugated medium, and coated duplex board totaled about 8.3mnt (up 5% YoY), 4.9mnt (up 9% YoY), and 2.56mnt (down 11% YoY). The firm's production capacity for paper and pulp reached about 20mnt (up 1.9mnt YoY) and 2.9mnt (up 2mnt YoY) in FY23.
　　Net loss per tonne narrowed QoQ in 2HFY23. ASP fell 11% QoQ　and cost per tonne declined 12% QoQ (thanks to falling domestic wastepaper and coal prices). As a result, GM grew 1.1ppt QoQ to 3% in 2HFY23. We estimate net loss per tonne at Rmb144 in FY23 (vs. net profit of Rmb205 in FY22), and net loss per tonne at around Rmb125 in 2HFY23 (narrowing HoH).
　　Financials: Net operating cash flow rose 139% YoY to Rmb6.9bn in FY23. Capex amounted to a record high of around Rmb17.7bn. NDP expects its FY24 capex to total about Rmb13bn. In FY23, NDP actively exchanged foreign currencies, and the proportion of renminbi borrowings increased to 93%. The firm expects the proportion to rise further.
　　In FY23, NDP’s gearing ratio rose 7ppt YoY to 63%, and its net gearing ratio grew to 103%. The firm expects its gearing ratio to peak in FY24 and begin to recover afterwards.
　　Trends to watch
　　Price hikes in peak season amid low inventory; net profit per tonne　to recover mildly. As the industry enters the peak season in 3Q and downstream restocking begins, paper producers’ order volume has risen marginally, and inventories at paper producers have declined slightly. We note that inventories have not increased notably since September, and paper producers have accelerated their price hikes. For example, NDP’s Dongguan base has launched seven rounds of price hikes (totaling over Rmb300/t) in 3Q23.
　　According to our survey, the price increases for mid-range to low-end products have mostly been implemented, while price increases for mid- range to high-end products are slightly under pressure. Given the concentrated incremental supply (e.g., Shandong Sun Paper Industry’s 1mnt capacity commenced operation in August-September; over 1mnt capacity is likely to be added by other paper producers in 2023), the recovery in earnings and share prices in the sector may be weaker than in the previous two cycles.
　　Slows down construction of several bases; balance sheet　manageable. According to corporate filings, as of June 2023, NDP’s production capacity rose 25% YoY to about 24.6mnt (including paper and pulp, unless otherwise stated). The firm expects its production capacity to increase 10% and 26% YoY to 30.9mnt in FY24.
　　The firm has slowed down the construction of several production bases, including paper (1.2mnt/yr capacity for ivory board paper, 0.3mnt/yr for corrugated medium, and 0.2mnt for kraft paper), pulp (chemical pulp and chemi-thermomechanical pulp), and wood fiber in overseas markets. The firm expects its FY24 capex to total about Rmb13bn (notably lower than previous guidance).
　　Corporate filings show that NDP had Rmb55.2bn of unused credit quota as of end-FY23. The firm’s cash on hand totaled about Rmb10.3bn, implying a manageable balance sheet.
　　Financials and valuation
　　We keep our FY24-25 earnings forecasts unchanged at Rmb2.5bn and Rmb3.5bn. The stock is trading at 0.4x FY24e and 0.3x FY25e P/B. We maintain an OUTPERFORM rating and target price of HK$6.30, implying 0.6x FY24e and 0.6x FY25e P/B with 42% upside.
　　Risks
　　Weaker-than-expected demand; higher-than-expected incremental supply in the sector; intensifying competition; higher-than-expected gearing ratio.