24 The first half of the fiscal year turned a loss into a profit. The most difficult period may have passed. Nine Dragons Paper expects 1HFY24 to achieve net profit attributable to the parent company of 200-40 million yuan, turning a loss into a profit over the previous year (1HFY23: -1.39 billion yuan). The improvement in profits was mainly due to: 1. A year-on-year increase in sales; and 2. The decline in raw material costs was greater than that of ASP, and gross margin increased year-on-year. Although 1HFY24's profit margins are still low, we believe the most difficult phase is over. We expect that in 2024, the new production capacity for box board corrugated paper is expected to decrease, imports will be disrupted or marginally slow, and the restoration of supply and demand will usher in better conditions.

Although there are still challenges in the short-term market, the industry's inflection point is getting closer. Keeping the company's FY24/25/26 EPS 0.13/0.68/0.68 unchanged, the target price was lowered by 3.4% to HK$4.66, based on 0.44 times FY2024 P/B (BPS: $9.63), which is 1 standard deviation lower than the average since 2009, to reflect the decline in the center of demand growth. Since November, the company's stock price has outperformed the HSCEI index by 27%, or does not fully reflect the company's potential turnaround. Upgraded to “Buy”.

Supply growth is expected to slow down, and there are better conditions for supply and demand recovery

With an obvious marginal improvement in demand in 2023, the overall corrugated board market is still under great pressure. We believe that the worsening supply-side situation is the most important reason. According to our statistics, the production capacity for corrugated board was increased by 5.85 million tons/year in 2023, the largest increase in production capacity since 2015; in early 2023, tariffs on recycled box board paper and corrugated paper were reduced to 0%, compounded by the easing of overseas supply and demand, and the impact on imports also increased significantly. We expect the supply situation to improve in 2024, the expansion of domestic production capacity is expected to slow down, and the increase in imports is also expected to weaken significantly. With the further increase in demand, there are better conditions for repairing the supply and demand relationship in the box board corrugated paper industry.

Off-season market challenges may continue

Since the end of November, with the support of the Spring Festival peak season, the price of corrugated box board has continued to recover moderately (cumulative margin is about 30 yuan/ton), but there have been many twists and turns in the middle of the process. We think this reflects the fact that the current supply and demand relationship in the industry is still weak. With the 1HCY24 market generally in the off-season, we expect that the market may still have challenges, and paper prices and corporate profits may still be difficult to recover significantly in the short term. However, as production capacity is gradually digested at the end of 2023, we expect the restoration of the supply and demand relationship in the 2HCY24 industry to be more sustainable.

Fiber production capacity investment is expected to enhance competitiveness

While slowing down the pace of commissioning some of the paper production capacity, the company's upstream wood pulp/wood fiber production capacity is expected to be launched relatively quickly in the 2024 fiscal year. We expect the total production capacity of wood pulp and wood fiber to reach 5.67 million tons/year by the end of fiscal year 2024. The ratio of wood pulp and wood fiber production capacity to paper production capacity is expected to reach 33%, and cost control is expected to increase. As the balance between supply and demand in the industry is gradually getting closer, we expect the company to gradually enjoy the resonance of the industry's overall supply and demand improvement and its own competitiveness, and profit recovery is expected to achieve strong elasticity.

Risk warning: Consumption is picking up more slowly than expected, exports are steadily slower than expected, and supply investment is stronger than expected.