Lee & Man Paper Manufacturing’s stock price has corrected by 15% from HK$10.94 in end-September2017, as the price of containerboard dropped from Rmb6,700/t in October 2017 to c.Rmb 5,200/t atpresent. Nonetheless, we remain optimistic on the company’s growth outlook on the back of positivelong-term structural changes in the containerboard industry, and expect its 2H17 earnings to reachc.HK$29bn （+103% YoY）。 We maintain our EPS forecasts of HK$1.12 in 17E （+77.8% YoY）， HK$1.21 in18E （+8.0% YoY）， and HK$1.36 in 19E （+12.4% YoY）。 We transfer coverage of the stock and lift ourtarget price from HK$9.50 to HK$10.50, representing 2x 18E PB and 9x 18E PE. With 15% upside, wemaintain our Outperform rating.
Margin expansion in 2H17. We expect the company’s total sales to reach 2.88mt in 2H17E （vs 2.77mtin 1H17 and 2.96mt in 2H16）， with an average selling price （ASP） of HK$4,424/t （+HK$295/t HoH;+HK$1055/t YoY. We forecast unit cost to reach HK$3,139/t （+HK$121/t HoH; +HK$492/t YoY），resulting in 2H17 unit gross margin of HK$1,285/t （+HK$174/t HoH; +HK$564/t YoY）。 The strongexpansion in margin during the peak season reaffirms our view of a positive long-term structuralchange in the containerboard industry, and we expect this to continue to manifest in Lee & ManPaper’s results as a margin expansion in 2018.
Promising outlook for 2018. We expect the firm to record steady improvement in orders as thegovernment introduces more stringent environmental regulations, such as environmental taxes, tocrack down on outdated capacity, and making approvals for new capacity more difficult to obtain.
We believe the new regulation on old corrugated cardboard （OCC） imports will decrease total OCCusage from 28mt in 17E to c.20mt in 18E, while the top-three paper producers, Nine Dragons Paper（2689:HK – BUY）， Anhui Shanying Paper Industry （600567:CH – BUY）， and Lee & Man Paper, accountfor 71% of total OCC imports. As such, we believe it will become more and more difficult for smallmills to import OCC, and we expect an increasing number of them to be forced out of the market. Wenote the price of OCC in southern China bounced back from Rmb2,000/t to Rmb2,200/t at present.
Meanwhile, we expect containerboard price to bottom out as demand recovers in 2018. We alsoforecast Lee & Man’s tissue paper capacity to increase from 0.5mt to 0.8mt in 2018E, amid positiveprofitability guidance by management.
Maintain Outperform. If the structure of the paper industry continues to improve, we remain bullishon Lee & Man’s long-term outlook. We maintain our EPS forecasts of HK$1.12 in 17E （+77.8% YoY），HK$1.21 in 18E （+8.0% YoY）， and HK$1.36 in 19E （+12.4% YoY）。 We lift our target price from HK$9.50to HK$10.50, representing 2x 18E PB and 9x 18E PE. With 15% upside, we maintain our Outperformrecommendation.