China packaging paper-Cash margin is still growing:Earnings cut to reflect Vietnam plant delay, but

Action: Stay bullish; overhang on Vietnam removed

    We believe the resumption of construction work at Lee & Man Paper’s (LMP)Vietnam plant would be positive for the stock in the long term as it hasremoved an overhang from possible investment cancellation and thesubsequent loss, which has been a concern for investors. We cut LMP’s andNine Dragons’ (ND) FY15F (YE-Dec) and FY16F (YE-Jun) earnings by 5%and 3%, respectively, in order to reflect the likely delay in commencement ofoperations of both companies’ Vietnam plants to 1HCY16 from 2HCY15F. Wenow assume both LMP’s and ND’s Vietnam plants to be completed in mid-

    CY16 vs. mid-CY15F previously.

    Catalysts: Net supply in CY15F may be negative and lower than expectedDespite flattish ex-factory prices since early July 2014, we note that growth of cashmargin has remained in positive territory since early August 2014, when itrecorded positive growth for the first time in two years, thanks to the weakening ofOld Corrugating Container (OCC) prices. We believe the ex-factory prices willlikely remain stable till the end of this year. We maintain our positive view for 2015and continue to expect a price hike of 1% in 2015 vs. 2014. We note that overallcapacity retirement in 2015F could be much higher than 4.62mn tonnes in 2014F.

    This would be the case as, apart from capacity closures ruled by the Ministry ofIndustry and Information Technology (MIIT), there will be at least 3-4mn tonnes ofadditional capacity closure by the end of 2015F in Dongguan Shuixiang areainitiated by Guangdong province. With the likely higher-than-expected capacityclosure and our estimated substantial slowing down of newly added capacity, wenow believe that net supply would see negative growth (vs. our currentassumption of 3.5% capacity growth in 2015F).

    Valuation: Maintain ND’s TP at HKD7.10; LMP’s TP cut to HKD5.60

    We trim our target price for LMP to HKD5.60 (from HKD5.90/shr) in order toreflect the likely delay in commencement of operations of the Vietnam plant.

    Our target price of HKD5.6/shr is based on its mid-cycle valuation of 12.3xFY15F P/E (EPS: HKD0.45). For ND, we maintain our target price of HKD7.10,which is based on half-standard deviation below the mid-cycle valuation of12.7x FY15F P/E (pre-exceptional EPS: CNY0.45). Based on our revisedearnings, we expect LMP to deliver pre-exceptional EPS CAGR of 12.7% overFY14-16F, while ND should deliver pre-exceptional EPS CAGR of 17.8% overFY14-16F. We reiterate our Buy rating on both companies.