Summary

Nine Dragons Paper holding limited (Nine Dragons or company) is the largest container board producer, also among the biggest in the world. At present, its business covers the Pearl River Delta, the Yangtze River Delta, the Middle and the West as well as the North of China with producing bases located in Dongguan, Taicang, Chongqing and Tianjin.

In 1H09, Nine Dragons`s performance rebounded fast benefiting from the bottom up of Chinese economy, recording net profit of RMB1.34billion, 63.0% increase y/y. Given the continued boom of this sector, we expect its net profit will be RMB2.20billion and RMB2.56billion in FY09/10 and FY10/11, increasing 32.7% and 16.0% y/y respectively, suggesting EPS of RMB0.48 and RMB 0.56.

Combined accounting, we initiate rating with Hold, 12-month TP of HK$11.00.

Profitability rebound fast with demand stabilized in 1H09

Under the circumstances of Chinese economic rebound, Nine Dragons present roller coaster-type wave in its profit performance, due to its high financial and operating leverage. In 1H09, it recorded total revenue of RMB6.80billion, cut 8.5% y/y, yet net profit of RMB1.34billion, 63.0% increasing y/y.

Meanwhile, Nine Dragons`s profitability presents a positive relativity to the industry boom. In 1H09, its gross margin and net profit margin rebounded fast to 22.9%/19.7% versus the 12.6%/5.1% in 2H08.

Generally, given the strong recovery of domestic economy, we think packaging paperboard sector will continue its boom, suggesting further growth in downstream demand. Furthermore, oversea waste paper price keeps up leading slower gross margin increase of this sector, so Nine Dragons`s profitability increase will be more dependent on internal control of cost and expenses.

Capacity expanding restarts, domestic layout tends to complete

With degree of industry performance recovers, Nine Dragons restarted its capacity expanding in 2009. Its fourth producing base in Tianjin has launched to produce in September 2009, with new added capacity of 800,000 tons. At present, its total designed capacity has reached to 8,820,000 tons, adding 22% from that of June 2009, successfully accomplishing the strategic layout of the four main producing bases, i.e., Dongguan, Taicai, Chongqing and Tianjin.

Considering the acceleration of domestic demand and translocation to inner area of this sector, we believe Nine Dragons`s capacity layout will follow this trend. Besides, with stabilization of oversea investment conditions, we expect it will add investment in Vietnam to seize the industry shifting opportunities in Southeast Area.

Financial risk obviously drops, with placing raised RMB2.8billion

On Oct. 28 2009, Nine Dragons succeeded to raise HK$2.80billion by placing 6.1% of the outstanding stocks with HK$10.85 per share, indicating the previous debt crisis would suspend for a while.

Up to June 2009, Nine Dragons`s liability/asset ratio was 55.6%, slightly lower than the 58.5% during the crisis in 2008. We expect its liability/asset ratio should have dropped to 48% in December 2009 after this share placing, lower than the caution line of 50%.

Risks

Up risks:

1. Packaging paperboard price rises beyond expected.

2. Oversea demand recovers better.

Down risks:

1. Waste paper price increases higher than expected.

2. Capacity excess in this sector is more serious.

Business strategy shifted from aggressive to stable, we initiate with Hold

Suffered from the financial crisis in 2009, Nine Dragons`s business strategy has begun to shift from the aggressively model of high lever for high growth to sound modest growth. Also, the management recently promised to gradually drop the debt ratio to 60% in next three years, a signal indicating the entering into maturity stage.

Looking forward, Nine Dragons will continue to benefit from the global economic recovery, and maintaining its leading position in this sector. Meanwhile, it will expand to upstream chain to guarantee sufficient paper pulp and waste paper supply for its need with stale price.

We expect its net profit will be RMB2.20billion and RMB2.56billion in FY09/10 and FY10/11, increased 32.7% and 16.0% y/y respectively, suggesting EPS of RMB0.48 and RMB 0.56. Combined accounting, we initiate rating with Hold, 12-month TP of HK$11.00.

Financial Data Ⅰ

Financial Data Ⅱ

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