Vested. From UOB-Kay Hian
Key takeaways from small group analyst meeting
Nine Dragons Paper (ND) held a small group analyst meeting yesterday. During the meeting, management addressed most of the investors’ concerns, including the movement of ASPs, margin trend, domestic demand, upward integration and impact of the Sichuan earthquake.
We still believe ND’s underperformance is unjustified, especially when there is no material change in fundamentals and that the growth of the whole paper manufacturing industry in China remains intact. We appreciate management’s efforts to improve its transparency after the stock’s sell-off.
ND’s ASPs were on an uptrend during Feb-May 08. The Group has successfully passed on the full impact of the increase in raw material prices in 3QFY08. The Group’s gross margin improved from 23.6% in 1HFY08 to 24.6% in 3QFY08 and even higher in 4QFY08 due to the ASPs hike.
Management believes there is room for further margin improvement due to better economies of scale. Raw material and waste paper prices, as discussed before, remain stable and soften a little in June. The waste paper prices from Europe peaked out in 4Q07. The 1.1d grade waste paper price
reached 89.3 Euro/tonne, the lowest since mid-Apr 07. ND has increased its sourcing of waste paper locally, which drags down overall waste paper costs. Given the softening of the OCC prices, the Group believes the room for further ASPs hike is limited in the short term.
The installation of the new paper machines (PM) is smooth and the improvement in utilisation rate of the new PMs is on track. The utilisation of the existing PMs remains as high as 92-96%. The utilisation rate of the new PMs is expected to reach over 80% in July and there is limited pressure on overall profitability.
The demand for light weight packaging paper is strong. Despite the capacity expansion, the Group’s finished goods level remains healthy and there is no issue of inventory pilling up. Local sales
reached 65% of total sales in June and management expects local sales as a percentage of total turnover to continue to increase in the coming quarters. According to a report from RISI (released at end-April), the demand for containerboard is still higher than the supply up to 2012 with an expected shortfall of 900,000 tonnes of containerboard in 2012.
The Group has delayed its discussions with overseas players regarding the upward integration given the currency movement. However, we still believe it is likely to announce the developments of upstream projects such as forestry and pulp in the next 9-12 months. The operation in Vietnam is performing well after ND took over in May. Sales of its operation in Vietnam are in terms of US dollar and the movement of the Vietnamese Dong has no impact on its sales. Management believes the demand for containerboard will increase by 10-20% each year. The profitability of the operation in Vietnam is expected to be higher than that in China, given lower operating costs.
The only negative surprise to us is the delay in the installation of the new PMs (22,23 and 27-30) due to the impact of the Sichuan earthquake. According to management, the operation of the PMs 22-23 (in Chongqing) will be delayed by 1.5 months as the Group has to strengthen the buildings and PMs in Chongqing due to the impact of the earthquake. The Group has showed notices from DongFang Electric (1172 HK) regarding the delay in delivery of the power generator to ND due to the distortion of production.
The installation of PMs 27-30 is likely to be delayed by eight months. We share the view that the Group’s growth in FY10 will be affected as PMs 27-30 would be the major growth driver of the Group in FY10. However, the growth will only be delayed and the impact on the Group’s overall growth is minimal. Our target price for ND is under review due to the postponement of installation of new PMs 27-30 but we do not expect to make a major change to it.