1HFY24 results in line with our and market expectations
　　Nine Dragons Paper (NDP) announced its 1HFY24 results: Revenue fell 1.9% YoY to Rmb30.6bn, net profit turned around to Rmb292mn (at the median of preannounced earnings) (vs. -Rmb1.39bn in 1HFY23), in line with our expectations. Our comments are as follows:
　　Sales volume up 17% YoY; ASP bottoming out. In 1HFY24, domestic demand was lackluster despite the peak season. Short-term restocking drove up prices slightly, but this was not sustainable. We estimate domestic new production capacity exceeded 4mnt in 2H23, and imports totaled 4.58mnt (+1.52mnt YoY). We think supply and demand conditions are under pressure.
　　We estimate that the firm's ASP fell 17% YoY and 4% HoH to Rmb3,050/t in 1HFY24. The firm announced that its sales volume rose 18% YoY and 25% HoH to about 10mnt, mainly driven by containerboard (+1.70mnt).
　　Net profit per tonne turned around, but remained at a historical low. We estimate net profit per tonne at about Rmb29/t (vs. -Rmb163/t in 1HFY23 and Rmb333/t in 1HFY22). Prices of pulp-based paper recovered notably in 4Q23 (accounting for around 18% of total sales volume), which may be attributable to the firm's stronger-than- expected quarterly earnings, in our view.
　　In addition, the firm optimized the product mix of packaging paper in 1HFY24. Sales volume of corrugated medium declined slightly, while that of high-end containerboard increased markedly.
　　FY24 capex and financial expenses remained elevated. In 1HFY24, the firm's financial expenses rose 8% YoY to Rmb600mn from a high base, mainly due to increased bank loans for capacity expansion. Capex was Rmb6.6bn, and operating cash flow and net free cash flow came in at -Rmb2.5bn and -Rmb9.1bn, under notable pressure.
　　The firm expects its capex to total Rmb13bn in FY24 (vs. Rmb17.7bn in FY23), down YoY but remaining high. Corporate filings show that NDP had Rmb42.3bn of unused credit quota as of end-2023.
　　Trends to watch
　　Sharper-than-expected impact from imported paper, but impact from incremental supply easing marginally. In 2023, China eliminated tariffs on some imported paper. Data from the General Administration of Customs of China (GACC) shows that the full-year import volume of containerboard and corrugated medium reached 8.54mnt in 2023, an increase of 2.9mnt YoY.
　　We think the elimination of import tariffs highlights the cost advantage of imported paper amid weak domestic demand and incremental supply. Moreover, we note that paper imports from Southeast Asia have directly affected the southern China market, leading to price competition. NDP’s key base is located in Dongguan in southern China.
　　In 2024, we believe the volume of imported paper is likely to remain at a historical high, but the impact of incremental supply may ease. Meanwhile, we think rising marine freight rates and higher costs of foreign waste paper may further increase the cost of imported paper, easing the impact on domestic paper prices.
　　Rapid capacity expansion as expected; cost advantage recovering. NDP announced that it had put into operation the scheduled capacity since 3Q23, including 800,000t/yr of kraft linerbord, 550,000t/yr of printing & writing (P&W) paper, and 200,000t/yr of chemithermomechanical pulp in Beihai, as well as 300,000t/yr of corrugated medium in Malaysia and 100,000t/yr of wood fiber in Vietnam. The total paper and fiber capacity has exceeded 25.8mnt/yr.
　　The firm announced that it plans to delay its 600,000t/yr and 1.1mnt/yr chemithermomechanical pulp production capacity in Beihai by one quarter to 3Q24. The firm plans to change the 1.2mnt/yr containerboard and corrugated medium capacity in Hubei into 600,000t/yr P&W paper capacity (to be put into operation in 2Q25). We think unlike in previous capacity expansion cycles, NDP is adjusting the pace and categories of product production in the current cycle, focusing on diversified product mix and integrated value chain.
　　We believe leading companies with captive power plants did not enjoy advantages in energy costs, as coal prices stayed elevated in 2021-2023 We note that the industry cost curve was at one point flattened. However, we think leading companies may regain their energy cost advantages once coal prices fall.
　　Financials and valuation
　　We keep our FY24 and FY25 earnings forecasts unchanged. The stock is trading at 0.3x FY24e and 0.3x FY25e P/B. We maintain OUTPERFORM and TP of HK$4.9, implying 0.5x FY24e and 0.5x FY25e P/B with 29% upside.
　　Risks
　　Weaker-than-expected demand; higher-than-expected incremental supply in the sector; sharper-than-expected impact from imported paper; higher- than-expected gearing ratio.