Preannounced FY23 attributable net loss at Rmb2.2–2.6bn
　　Nine Dragons Paper （NDP） preannounced results for FY23 （ended June 30, 2023）： Attributable net loss may reach Rmb2.2–2.6bn, with the median at Rmb2.4bn. In 2HFY23 （1H23）， attributable net loss may total Rmb800mn–Rmb1.2bn, missing market expectations due to sharper-than- expected price declines. Our comments are as follows:
　　Sales volume remains stable. The firm’s high-end containerboard production facility, with production capacity of 600,000t/yr, started operation in Jingzhou, Hubei in 4Q22. We estimate its sales volume may exceed 16mnt in FY23 and approach 8mnt in 2HFY23 （+5% YoY）。
　　Paper prices at a five-year low due to multiple negatives. Weak domestic demand, slowing exports, and the impact of imported paper weighed on paper prices in 2HFY23. Data from RISI shows that prices of containerboard and corrugated medium fell Rmb455 and Rmb376 HoH to about Rmb4,550/t and Rmb3,500/t in 2HFY23.
　　Data from the General Administration of Customs of China （GACC） shows that import volume of containerboard and corrugated medium rose 53% YoY and 29% HoH to 3.95mnt in 2HFY23. We note that the firm's Dongguan base faced strong pressure from imported paper （mainly from Southeast Asia）， earnings of its core base in southern China came under pressure, and overall demand in other regions （e.g., eastern and northern China） remained relatively stable.
　　Net loss per tonne narrows HoH on easing cost pressure. In 2HFY23, coal prices fell rapidly and domestic wastepaper prices fell by over Rmb400/t HoH. We believe that leading players are regaining their cost advantage, which they lost in the past two years.
　　We estimate that net loss per tonne averaged about Rmb125/t in 2HFY23, and the loss narrowed HoH （vs. a loss of Rmb160/t in 1HFY23）。 Given high shutdown expenses and slightly elevated costs in 1Q23, we expect to see concentrated losses in 1Q23 and a QoQ recovery in 2Q23.
　　Trends to watch
　　Weak recovery in net profit per tonne may continue in 1HFY24. Paper prices hit a historical low in 1H23, and the paper industry has suffered losses for five consecutive quarters. We see limited downside in share prices of industry leaders after multiple stress tests. Since August 21, industry leaders have launched two rounds of price hikes （totaling Rmb60-100/t）， and most of them have been implemented, according to our survey.
　　We expect the containerboard and corrugated medium sectors （highly correlated with retail sales of consumer goods） to start restocking and price hikes if demand recovers. However, given the concentrated incremental supply （e.g., Shandong Sun Paper Industry’s 1mnt planned capacity in September）， the recovery in earnings and share prices in the sector may be weaker than in the previous two cycles.
　　Critical period for capacity expansion; balance sheet manageable. According to corporate filings, NDP had about 21.3mnt of designed production capacity as of end-2022 （including paper and pulp, unless otherwise stated; pulp production capacity at 2.6mnt）， up 12% from end- 1H22. The firm estimates its design production capacity will increase 53% to about 32.50mnt by end-2024.
　　In the next two years, the firm plans to continue to develop virgin kraft linerboard and ivory board paper. We believe its expanded product portfolio could strengthen the firm’s bargaining power in packaging papers. Furthermore, NDP aims to produce pulp and wood fiber to strengthen the margin of safety for pulp-based paper.
　　The firm guides FY23 capex at more than Rmb18bn, and we expect it to remain elevated in FY24. Corporate filings show that NDP had Rmb62.4bn of unused credit quota as of end-2022. The firm’s cash on hand totaled about Rmb9.6bn.
　　Financials and valuation
　　Given the sharper-than-expected decline in paper prices, we cut our FY23 and FY24 net profit forecasts from -Rmb0.87bn to -Rmb2.3bn and from Rmb5.4bn to Rmb2.5bn. We introduce our FY25 net profit forecast of Rmb3.5bn. The stock is trading at 7x FY24e and 5x FY25e P/E. We maintain an OUTPERFORM rating. Due to valuation rollover to FY24 and the sector's earnings recovery, we cut our target price 16% to HK$6.3, implying 10x FY24e and 7x FY25e P/E with 45% upside.
　　Risks
　　Higher-than-expected incremental supply in the sector; weaker-than- expected demand; sharper-than-expected impact from imported paper.