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Lee & Man Paper [2314.HK]

Mark Po, CFA — Senior Analyst

(852) 3698-6318

markpo@chinastock.com.hk

Wong Chi Man, CFA —Head of Research

(852) 3698-6317

cmwong@chinastock.com.hk

China Materials -

Paper

New paper products to drive growth. Initiate with BUY

BUY

Close: HK$5.88 (Jul 11, 2016)

Target Price: HK$7.0 (+19.0%)

Share Price Performance

Market Cap US$3,453m

Shares Outstanding 4,580m

Auditor Deloitte Touche Tohmatsu

Free Float 31.4%

52W range HK$3.92-5.94

3M average daily T/O US$4.3m

Major Shareholding Lee Family (55.1%)

July 12, 2016

Lee and Man Paper (LMP) manufactures and sells paperboard packaging products, pulp and tissue paper. It Is the second largest containerboard manufacturer in China with annual capacity of 5.23m tonnes. Unlike other cyclical industries, paper demand is not closely correlated with investment activity; it is more closely related to local consumption. We believe the paper manufacturing industry will be one of the long-term beneficiaries of China’s consumption growth and supply-side reform policy. Through increasing exposure to the tissue paper segment, LMP will benefit from consumption growth in China. A further consideration is that government policies, such as more stringent environmental protection controls and increasing land costs, create entry barriers for potential competitors. With an improving supply and demand situation and strong growth in tissue paper operations, we expect LMP to post a 10.3% top-line CAGR and 10.9% bottom-line CAGR in 2016-18E. LMP is now trading at 10.1X 2016 PER. With its undemanding valuation, we initiate coverage on LMP with a BUY rating and a target price of HK$7.0 (based on 12x 2016E PER, in line with its historical average and the average of its listed peers).

More favorable supply/demand situation. Given tight market liquidity and a decline in profitability,

paper industry FAI has seen a significant slowdown since 2014. Paper industry FAI reported YoY growth of only 6.4% in 2014 and 0.4% in 2015, a significant slowdown from 18.8% in 2013 and 15.5% in 2012. Paper industry FAI slowed down further to a 5.6% YoY decline in Jan-Apr 2016. The paper industry is expected to report a continued slowdown in new capacity expansion in 2017 and 2018. With the govern-ment policy of supply-side reform and increasing environmental protection controls, local governments in southern China have been aggressively shutting down small paper manufacturing plants, and the lead-ing paper manufacturers, including LMP and Nine Dragons Paper [2689.HK] (NDP), are major benefi-ciaries. We believe other local governments will follow, which is positive for the major paper producers. The government policy of supply-side reform will be implemented more easily in the paper industry than for other commodities because the paper industry is dominated by non-SOE-related companies and does not suffer from the structural problems of SOE involvement. The leading players, including LMP, will be the major beneficiaries of industry consolidation. We expect LMP’s sales volume of packaging paper to grow modestly at 7%, 1% and 0.4% in 2016-2018, respectively, reaching 5.7m tonnes in 2018. Despite slower volume growth, LMP’s profitability in the packaging paper business will report faster growth, in our view, due to a gradual improvement in its utilization rate and operating efficiency.

Tissue paper is one of the growth drivers. LMP sold 48,000 tonnes of tissue paper in 2015, 90% of

which was sold to jumbo roll manufacturers in Chongqing on an OEM basis and 10% of which was used internally. The Company will expand its tissue paper capacity from 140,000 tonnes in 2015 to 355,000 tonnes by the end of 2016. After completion of the expansion, LMP will become one of the top five tissue paper companies in China in terms of capacity. LMP’s sales volume of tissue paper is expected to reach

150,000 tonnes in 2016. Its tissue paper operations will become one of LMP’s growth drivers in the near term. The ramp-up of LMP’s new tissue capacity in its Chongqing production base will also start contrib-uting to sales growth going forward. Tissue paper is expected to account for 14% of LMP”s turnover in 2017 vs. 7% in 2015. LMP has a cost advantage over the other leading players, because the Company has in-house power and steam plants, internal pulp supply and better infrastructure.

Waiting for new expansion plan for growth in 2018 and beyond. LMP’s internal cash flow is more

than enough to fund its capacity expansion in 2016 and 2017, based on its current expansion plan. Management hinted the company will release a new expansion plan for 2017 and beyond later this year. The market has factored in only a flat YoY change in operating performance in 2018, so the release of the new development plan should trigger an upward revision to forecasts for 2018. Management is bull-ish on the Vietnam market, which is growing at a 10% CAGR. Management also highlighted the fact that LMP is not reliant solely on the Chinese market; it will focus on expansion in overseas markets. LMP is also considering geographical expansion and is looking for a suitable site to establish a production base outside Chongqing.

Risks: (1) lower than expected paper demand, (2) faster-than-expected capacity expansion by industry

peers; and (3) a substantial increase in the cost of production.

Key Financials (in HKDm) 2014 2015 2016E 2017E 2018E

Revenue 17,099.1 17,615.6 20,238.7 22,710.7 23,624.4

Change (YoY %) 0.8 3.0 14.9 12.2 4.0

Gross Profit 3,071.6 3,578.3 4,153.8 4,786.5 4,991.4

Gross Margin % 18.0 20.3 20.5 21.1 21.1

Net Profit 1,904.4 2,331.8 2,670.1 3,064.3 3,179.9

Net Margin % 11.1 13.2 13.2 13.5 13.5

EPS (Basic) 0.41 0.50 0.58 0.67 0.69

Change (YoY %) (1.9) 23.9 15.6 14.8 3.8

DPS $0.143 $0.180 $0.216 $0.259 $0.270

ROE (%) 11.3 13.4 14.9 15.9 15.4

Dividend Yield (%) 2.46 3.10 3.72 4.46 4.64

PER (x) 14.3 11.5 10.0 8.7 8.4

PBR (x) 1.6 1.5 1.4 1.3 1.2

FCF Yield (%) 3.41% 4.65% 3.44% 8.59% 10.96%

Capex (m) (2,093.3) (2,849.5) (2,600.0) (1,800.0) (1,800.0)

Free cash flow per share 0.2 0.3 0.2 0.5 0.6

Net Gearing (%) 62.0 65.6 66.5 61.7 56.1

Sources: Company, CGIS Research estimates

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1) Better Supply/Demand Dynamics for the Packaging Paper Industry

Capacity growth should slow down and supply-side reform might change the mar-

ket dynamics. Along with other cyclical industries, the paper manufacturing industry was

under pressure in 2012-2014, given the slowdown in downstream demand and fast capac-

ity growth. The slower demand growth and strong new supply (due to higher paper FAI in

2011-2013) have been the major reasons for weak operating performance in the paper

industry since 2012. Total production of paper and paperboard grew 1.7% YoY in 2015,

down from 2.8% YoY in 2014, but an improvement from 0.9% YoY in 2013. Turnover for

the whole paper industry YoY increased 2.6% in Jan-Oct 2015, down from 5.2% in 2014,

5.9% in 2013 and 6.9% in 2012. Net profit for the whole industry increased 8.9% YoY in

Jan-Oct 2015, an improvement over the YoY decline of 4.7% in 2014, YoY growth of 7.0%

in 2013 and YoY growth of 3.6% in 2012

Paper FAI has been aggressive in since 2004, with average growth of 25.8% in 2004-

2009. Because of the impact of the global financial crisis, paper industry FAI grew only

8.5% YoY in 2010. Given expectations of demand recovery and loosening credit in China,

there was an aggressive increase in paper industry FAI in 2011, resulting in 42.5% growth

YoY. Paper industry FAI growth remained at a high level in 2012-2014, with an average

growth rate of 21.8%. The paper industry has experienced a downturn since 2012, given

the oversupply issue. Containerboard, a major category in the paper industry, also report-

ed the fastest capacity growth in 2011-2014, and the profitability of the leading players,

including LMP and NDP, was under pressure during that period. The slowdown in the

macro environment worsened the situation. Paper industry FAI slowed down significantly

in 2014, just 6.4% YoY in 2014 and 0.5% in 2015. Paper industry FAI decelerated further

in Jan-Apr 2016, with a YoY decline of 5.6% reported. Paper industry FAI is expected to

report slower growth in 2016 and 2017 given the economic slowdown and increasing mac-

ro uncertainties.

Actual capacity may not be as significant as expected. Based on the available infor-

mation, announced containerboard production capacity is estimated at 7.95m tonnes in

2016-2017, which is a very significant number compared to annual production of 44.7m

tonnes in 2015. There is concern about excess capacity given the strong new capacity

addition, assuming all new capacity goes on stream in 2016-2017. To clearly assess the

impact of the new production capacity, we examine several important factors.

1. Capacity reduction. The impact of the capacity reduction by the government, given

increasing environmental protection controls, will offset the new production capacity to

some extent. The Chinese government has announced a supply-side reform policy which

involves closing down old capacity.

2. Construction delays. Delays in construction works are quite common in the paper

industry. The impact of new production capacity may therefore be lower than the expecta-

tions of some market participants, given the worsening macro environment. The working

capital requirements (raw materials and accounts receivable) also put pressure on paper

manufacturing. Because of concerns about high inflation and excess capacity, it is unlikely

the government will loosen monetary policy significantly going forward. The leading paper

manufacturers, such as LMP, Nine Dragons Paper and Chenming Paper [1812.HK], are

slowing down their capacity expansion.

The paper industry was under pressure in 2012-2014.

Paper industry FAI reported negative growth in early 2016.

We are expecting slower ca-pacity growth going forward.

Investment positives

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3. Upgrading of existing products. There is increasing demand for lighter paper pack-

aging solutions with the same tensile strength for the same surface area in order to re-

duce shipping costs. Production of low-weight grade paper requires better technology and

in-house R&D, which creates barriers for smaller paper makers. Also, the smaller players

are becoming uncompetitive in the low cost products for downstream customers. The

leading paper manufacturers are fine-tuning their machines to produce light-weight paper,

for which there is less competition. The improvement in design capacity through product

upgrading is not fully reflected in the market forecasts.

4. Containerboard capacity expansion. We are factoring in the effect of new production

of containerboard of 2m and 1.8m tonnes in 2016 and 2017, respectively, lower than in-

dustry estimates. We still believe the capacity expansion of the containerboard industry

has peaked in the medium term. We do not expect the containerboard makers to ramp up

capacity significantly given the uncertain macro environment and new reform policy re-

garding supply. The containerboard market in China is on an improving trend given more

discipline in new capacity expansion and capacity reduction by the government.

Inventory adjustment cycle. The paper industry in China has been in an inventory

adjustment cycle since the beginning of 2016. The industry reported a YoY inventory de-

cline of 1.1% in Apr 2016 vs. a YoY increase of 3.2% in Dec 2015 and 6.8% in Nov 2015.

The industry outlook is improving sequentially though at a slow pace. The paper industry

in China is in better shape now than a year ago given the inventory reduction. The aggres-

sive capacity expansion of the whole industry in 2012-2013 has come to a halt, and we

expect the capacity utilization rate to rebound, with paper makers seeing improvement in

working capital management and likely to see less pressure from financial expenses after

the CAPEX peak.

Still a growing sector though at a slower pace. Demand for paper is highly correlat-

ed with economic activity, including consumption and exports. Historically, consumption of containerboard is highly correlated with GDP growth. We agree that consumption growth in China has been slowing down, but it has remained in positive territory, which should support packaging paper consumption growth. We also believe that e-commerce/express delivery can help drive demand growth for containerboard due to the extra layer of pack-aging usually required for shipping purposes. China's e-commerce retail sales grew strongly at a CAGR of 50% and accounted for 22% of total retail sales in 2015, up from 5% in 2010. The rapid growth in e-commerce has resulted in explosive growth in express delivery. The number of packages delivered recorded a CAGR of 55% in 2010-15. China’s GDP growth is expected to moderate further going forward, but paper demand is still growing, though at a slower pace. Based on GDP growth of 6.5% in 2016, paper demand is expected to grow at an annual rate of 2.8%. Given the slowdown in new supply, the utilization rate of China’s packaging paper industry is expected to improve going forward. The utilization rate of the packaging paper industry is expected to improve from 83.6% in 2015 to 83.7% in 2016 and then further improve to 89.1% in 2018.

Going through an inventory adjustment cycle.

A growing industry though at a slower pace.

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Overall paper production is still growing.

Figure 2: Paper Production and YoY Growth

Sources: WIND, CGIS Research

Figure 1: Paper Supply Chain

Sources: CGIS Research

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Paper Production YTD Paper Production YTD YoY YoY (%)

m tonnes

Raw Materials Pulp ManufacturingPaper

Manufacturing

Paper Grade

Forestry

Rice Wheat Grass

Wood,Bamboo

Pulp Manufacturing

Chemical Pulp

Mechinal Pulp,Semichemical Pulp Paper Manufacturing

Writing Paper

Packaging Paper

Household Paper

Industrial Use Paper, Speciality Paper and

Waste Paper Deink Pulp

Collection

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Slower turnover growth but margins are improving.

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Paper industry FAI reported negative YoY growth again.

Figure 4: Paper Industry FAI YoY Growth (%)

Sources: WIND, CGIS Research

Figure 3: Turnover and Net Profit for the Paper Industry

Sources: WIND, CGIS Research

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Overall industry profitability declined, but it is still in posi-tive territory, outperforming other commodities.

Figure 6: Percentage of Loss Making Enterprises in the Paper Industry

Sources: WIND, CGIS Research

Figure 5: Net Profit Margin of the Paper Industry

Sources: WIND, CGIS Research

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The paper industry is going through an inventory adjust-ment cycle.

Paper consumption growth is moving in line with GDP growth.

Figure 8: GDP Growth vs. Paper Consumption Growth

Sources: WIND, China Paper Association, CGIS Research

Figure 7: Paper Industry Inventory Cycle

Sources: WIND, CGIS Research

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Figure 9: Supply/Demand Situation for Packaging Paper In China Sources: WIND, China Paper Association, CGIS Research

Figure 10: Packaging Paper Consumption Growth vs. China GDP Growth

Sources: WIND, China Paper Association, CGIS Research

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Containerboard Consumption growth GDP growthYOY (%)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016F 2017F 2018F

Capacity (m tonnes) 40.9 44.6 47.5 50.5 52.2 53.5 55.5 57.3 58.5

New Addition (m tonnes) 3.1 5.7 5.2 5.4 3.9 2.8 3.5 2.8 2.2

Phase Out (m tonnes) 1.5 1 1

Capacity - YoY (%) 9.0 6.5 6.3 3.4 2.5 3.7 3.2 2.1

Production (m tonnes) 19.3 23.6 27 30.5 34.45 37.5 39.7 41 40.6 43.4 44.7 46.45 49.6 52.1

Production - YoY (%) 22.3 14.4 13.0 13.0 8.9 5.9 3.3 -1.0 6.9 3.0 3.9 6.8 5.0

Utilization rate (%) 91.7 89.0 86.3 80.4 83.1 83.6 83.7 86.6 89.1

Net import (export) -0.358 -0.2 -0.1 0.25 -0.62 -0.5 0.9 1.3 0.3 -0.8

Demand (m tonnes) 21.2 24.5 28.2 31.1 35.7 38.4 40.6 41.8 41.2 43.9 45.2 46.5 47.8 49.1

Demand - YoY (%) 15.8 15.1 10.1 14.9 7.7 5.7 3.0 -1.4 6.6 3.0 2.8 2.8 2.8

Suppy/Demand (deficit) (m tonnes) 0.9 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.0 1.1

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2) Tissue paper is a growth driver

In Nov 2014, LMP acquired two under-construction tissue paper production lines in Chong-qing from its controlling shareholder (Mr. Lee Wan Keung) for a consideration of HK$404m to enter the tissue paper production market in China. The market took a cautious stance on the transaction at the time since (a) the market was negative on the outlook for the tissue paper industry in China, partly because of the oversupply issue; and (b) the acquisition consideration for this connected transaction seemed higher than the industry average. Al-so, management disclosed limited details about the acquisition at the time, so the market didn’t pay attention the tissue paper operations. However, the tissue paper operation are a medium-long term growth driver and are likely to trigger a re-rating of the Company.

Fragmented market in China. According to the China Paper Association, production of household paper (including tissue paper) in China grew at a CAGR of 7.3% in 2006-2015, reaching 8.85m tonnes in 2015. Meanwhile, consumption of household paper in the country grew at a CAGR of 7.2% in 2006-2015, reaching 8.17m tonnes in 2015. The overcapacity situation was worst in 2014, but the situation improved slightly in 2015 as the major house-hold paper makers slowed down their capacity expansion plans. The tissue paper market in China is very fragmented. The top four players have only a 25% market share, and the remaining 75% market is shared among more than 1,000 producers. In Japan, in compari-son, the top four players have over a 50% share of the tissue paper market. Hengan [1044.HK], Vinda [3331.HK], APP and C&S Paper [002511.CH], the top four tissue paper producers in China, have a combined 25.3% market share in the country. Hengan, the larg-est tissue paper company in China, had annual capacity of 1.02m tonnes in 2015, and this will increase to 1.14m tonnes in 2016 based on its expansion plan. Tissue paper accounted for 42.2% of turnover and 33% of gross profit in 2015. Vinda, the second largest tissue pa-per company in China, had annual capacity of 950,000 tonnes in 2015, and this will in-crease to 1.05m tonnes by the end of 2016 based on its current expansion plan. The pro-duction capacity of APP and C&P Paper will reach 1.63m tonnes and 0.62m tonnes, re-spectively, by the end of 2016.

Demand for tissue paper in China grew at a CAGR of about 10% in 2006-2012, driven by increases in per capita consumption as income levels increased. Growth of the tissue pa-per market slowed down in 2013-2015 to 6-7% per annum because of the economic slow-down. In 2009-2015, tissue paper capacity in China increased at a CAGR of 10.8%, reach-ing 10.29m tonnes as new players entered the segment in 2012-2014. The top four players, including Hengan, Vinda, APP and China C&S Paper, also expanded their production ca-pacity by 80-136% during that period. The Chinese tissue paper producers’ operating mar-gins were under pressure from price competition driven by overcapacity. As a result, the industry’s average utilization rate dropped from 86% to 80% over the same period. Tissue paper overcapacity eased slightly starting in 2015 as more industry players began increas-ingly slowing new capacity additions. Given the overcapacity concerns, the top four players slowed their capacity expansion in 2015 and 2016. In 2015, their capacity expansion added only 325,000 tonnes of additional capacity in total, down from 730,000 tonnes in 2014. The planned capacity expansion by the top four players is 480,000 tonnes in 2016, a YoY in-crease, but still lower than the level in 2012-2014.

In 2014, China’s per capita consumption of household paper was 4.4kg, lower than world average of 4.5kg and much lower than developed markets, such as Europe’s 15kg, Japan’s 15kg and North America’s 25kg. Therefore, there is upside for per capita consumption of household paper in China, which offers long-term growth potential for domestic tissue pa-per producers. The major cost component in tissue paper manufacturing is pulp, which accounts for 50-60% of total production costs. On average, 1 tonne of pulp can produce 1.06-1.1 tonnes of tissue paper. Pulp price movements therefore have a significant impact on the profitability of tissue paper makers. However, the tissue margins of tissue makers (which contracted in 2013 and 2014) may have bottomed out, given declining pulp prices and more discipline in capacity expansion.

The top four players lead the market.

Overcapacity concerns have led to reduced capacity expan-sion.

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The China household paper market still has considerable upside.

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Based on our calculation, in 2015, LMP’s tissue paper segment achieved an ASP of HK$8,833 per tonne and a net margin of 7.7%, which is quite respectable compared with Vinda’s net margin 3.24% in 2015 (partly due to FX issues as Vinda imports pulp and bor-rows in USD) and C&S’s net margin of 3.0% in 2015. This shows that LMP is competitive in terms of manufacturing costs. LMP will become a sizable player in the domestic tissue pa-per industry in terms of capacity if it completes its expansion plan by the end of 2016. Its capacity will reach 335,000 tonnes by the end of 2016 vs. Hengan’s 1.14m tonnes, Vinda’s 1.04m tonnes and C&S’ 0.62m tonnes.

LMP is not aiming to compete with the big names, like Hengan and Vinda; its target is to gain market share from the smaller players, whose profitability is much lower and scale is much smaller. Since LMP concentrates more on the OEM market, we don’t expect the Company to have major marketing expenses to build its own brands and channels. The tissue business expansion should still be a key growth driver for LMP in 2016, 2017 and 2018.

LMP achieved respectable profitability.

Not aiming to compete directly with leading tissue paper brands.

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Steady growth.

Tissue paper capacity grew quickly starting in 2009 but has slowed down since 2015.

Figure 12: Tissue Paper Capacity in China in 2009-2015

Sources: China Paper Association, CGIS Research

Figure 11: China Household Paper Industry

Sources: China Paper Association, CGIS Research

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LMP will become a sizable do-mestic player.

Figure 13: Capacity Expansion by Major Chinese Tissue Paper Makers

Sources: China Paper Association, Company Data, CGIS Research

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3) Higher Profitability despite Strong Cyclical Industry Nature

Given its scale, good cost control capability, healthy balance sheet and good infrastructure, LMP has cost advantages over its listed peers. LMP ranks at the top in profitability among its global, regional and domestic peers, reflecting its strong cost controls, quality improve-ment and distribution efficiency. From a long-term perspective, although this is a cyclical industry, LMP has maintained strong profitability. Its gross margin and ROE are higher than the industry average, and we believe it is one of the best choices in the paper production sector regarding the supply-side reform theme. According to our analysis, LMP’s average net margin has been 14.7% in the last 10 years, while the average net margin of its listed industry peers has remained at around the 4.4 to 7.4% level. Except for 2009, LMP also reported higher ROE than the industry average because of its cost advantages and higher profitability.

LMP achieved higher than av-erage profitability.

Figure 14: LMP Ranked High in Terms of Profitability and ROE in 2015

Sources: Bloomberg, CGIS Research

LMP

NDP

Chenming

Youyuan

China Sunshine

Hengan

C&S Paper

Sun Paper

Huatai

Shanying

International Paper

Nippon Paper

Daio Paper

Cheng Loong

Westrock Mwv Llc

Stora Enso

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Higher than average gross margin and ROE among its listed peers.

Figure 15: Gross Margin—LMP vs. Average of Listed Peers

Sources: Bloomberg, Company Data, CGIS Research

Figure 16: ROE—LMP vs. Average of Listed Peers

Sources: Bloomberg, Company Data, CGIS Research

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Figure 17: Growth Drivers of China’s Paper Industry

Sources: CGIS Research

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4) Government-Led Industry Consolidation

Along with other cyclical industries, the paper manufacturing industry is in consolidation mode under the Chinese government’s policy of supply-side reform. Despite slower end demand growth, capacity reduction by local governments helped balance demand and sup-ply in 2015, and the leading packaging paper manufacturers reported improvement in prof-itability. In Guangdong, Dongguan’s municipal government set up a RMB1bn special fund to encourage small paper mills to shut down before the end of 1H 2015. On average, the paper mills which shut received about RMB21m. About 4m tonnes of packaging paper ca-pacity was eliminated in 2015, supporting price hikes in China in 2H 2015. In Zhejiang, Fuyang’s government has been promoting the closure of small paper mills since 2013, via leveraging higher environmental standards. This has already lead to closure of more than 100 paper mills.

On 25 May 2016, the NDRC published a list of 33 pilot Yangtze River Economic Develop-ment Zones in 11 provinces, including Shanghai, Jiangsu, Zhejiang, Anhui, Jiangxi, Hubei, Hunan, Chongqing, Sichuan, Yunnan and Guizhou. The NDRC noted that environmental protection will be prioritized over economic development in the 33 pilot zones. The con-struction of new capacity in petrochemicals, coal chemicals and other highly polluting in-dustries will be strictly prohibited. In addition, producers in industries including paper, elec-troplating, textile printing and nonferrous metals that are unable to meet the environment protection requirements will be shut down resolutely. The process of phasing out outdated paper capacity, especially in the 11 provinces mentioned above, will be accelerated, given the emphasis on the government’s environmentally friendly development theme.

Given China's supply-side reform and continued focus on shutting down obsolete capacity, we expect the closure of small or inefficient producers in the paper making industry to con-tinue in the 13th Five Year Plan, and the entry barriers for capacity addition will also rise with rising environmental standards. The paper sector, in our view, is among the few sec-tors where we see an improvement in supply/demand dynamics. The consolidation of the paper manufacturing industry will continue given increasing environmental protection measures and tighter market liquidity: Small to medium-sized paper mills will continue to see increasing cost pressure, while leading players, such as LMP and NDP, will continue to gain market share going forward.

The Chinese government is keen to shut down outdated capacity.

Figure 18: Paper Capacity Shut Down by Chinese Government in China in 2010-2014

Sources: China Paper Association, MIIT< CGIS Research

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Government's target Actualm tonnes

17

5) Cost Components Are Manageable

The key raw material for containerboard manufacturing in China is old corrugated contain-ers (OCC), which is therefore a major part of LMP's production costs, accounting for 57% of the cost of goods sold (COGS) in 2015. Local OCC prices are stable, but supply has been getting tighter recently with new demand from new capacity coming on-stream. US OCC prices moved up to US$182-185/tonne, partly because of a decline in the collection of waste paper during the low summer season. The paper mills are still taking a wait-and-see approach. OCC prices have been trending down since 2011 and should remain relatively flat in 2016 and 2017, with a slight downward trend. The local paper mills might also in-crease local sourcing of OCC to hedge the impact of RMB depreciation. Since the RMB depreciation in Aug 2015, LMP has increased its local sourcing of waste paper. Manage-ment believes that overall raw material cost movement will not have a major impact on prof-itability despite the upward movement in the US OCC prices. LMP will continue to adopt a flexible strategy in raw material procurement. Further consolidation will result in better con-trol over pricing from the leading paper makers’ perspective, and costs should remain sta-ble as local recycling rates improve.

Coal is another important raw material for LMP, as most of its production plants have their own internal power plants to generate electricity and steam for paper making. Coal ac-counted for 8% of LMP's COGS in 2015. Even if the coal price rebounds in 2016 or 2017, we expect LMP to be able to pass on the cost hikes to its downstream customers given its increasing pricing power. LMP also has a strong technological advantage in terms of ener-gy savings; it uses only 0.37 tonnes of standard coal to produce 1 tonne of paper, which is 38% less than the national average. LMP will continue to focus on efficiency gains to re-duce costs. For instance, it aims to cut per tonne coal consumption to 0.36 from the current 0.37.

OCC price expected to remain stable.

No major risk from coal price movement.

Figure 19: LMP’s Cost Breakdown in 2015 Sources: Company Data, CGIS Research

OCC, Pulp and

other chemicals74%

Energy

8%

Salary

5%

Depreciaiton

6%

Transportation

3%

Repairs &

maintenance4%

18

More favourable cost environ-ment.

Increased supply of domestic waste paper.

Figure 20: US OCC Price Movement Sources: WIND, CGIS Research

Figure 21: China Waste Paper Recycling Rate Sources: WIND,, CGIS Research

0

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100

150

200

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03/12 07/12 11/12 03/13 07/13 11/13 03/14 07/14 11/14 03/15 07/15 11/15 03/16

US OCC: 8# US OCC :11#US$/tonne

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19

Figure 22: Key Assumptions for LMP

Sources: Company, CGIS Research

2011 2012 2013 2014* 2015 2016F 2017F 2018F

Turnover (HKD m)

Linerboard 8,929.0 9,418.0 13,166.0 13,237.0 13,576.0 14,135.4 14,559.5 14,996.2

Medium 3,869.0 1,073.0 1,356.0 1,547.0 1,547.0 2,319.4 2,557.4 2,720.9

Whiteboard 1,539.0 601.9 1,800.9 1,531.0 1,394.0 1,886.0 1,886.0 1,886.0

Pulp 378.6 331.1 647.4 710.0 674.9 573.6 573.6 573.6

Tissue Paper 0 0 0 74.1 423.8 1,324.3 3,134.2 3,447.6

Total 14,715.6 11,424.0 16,970.4 17,099.1 17,615.6 20,238.7 22,710.7 23,624.4

YoY Change (%)

Linerboard 5.5 39.8 0.5 2.6 4.1 3.0 3.0

Medium (72.3) 26.4 14.1 0 49.9 10.3 6.4

Whiteboard (60.9) 199.2 (15.0) (8.9) 35.3 0 0

Pulp (12.5) 95.5 9.7 (4.9) (15.0) 0 0

Tissue Paper 471.6 212.5 136.7 10.0

Total (22.4) 48.6 0.8 3.0 14.9 12.2 4.0

Gross margin (%) 14.0 17.1 17.0 18.0 20.3 20.5 21.1 21.1

Linerboard 15.1 17.5 17.5 18.6 21.0 21.0 21.0 21.0

Medium 11.3 13.0 13.0 13.0 15.4 15.4 15.4 15.4

Whiteboard 14.2 17.0 17.0 17.0 18.6 18.6 18.6 18.6

Pulp 15.0 18.0 15.4 17.4 17.4 17.4 17.4 17.4

Tissue Paper 0 0 0 25.0 25.0 28.0 28.0 28.0

Net margin (%) 9.2 11.6 11.5 11.1 13.2 13.2 13.5 13.5

Cost (HKD m)

Cost of Sales (12,652) (9,473) (14,084) (14,028) (14,037) (16,085) (17,924) (18,633)

S,G&A (842.3) (660.2) (934.0) (1,038.9) (1,114.2) (1,247.3) (1,399.6) (1,456.0)

Financial Expenses (229.1) (335.4) (293.2) (178.7) (60.8) (73.7) (80.4) (86.9)

YoY Change (%)

Cost of Sales (25.1) 48.7 (0.4) 0.1 14.6 11.4 4.0

R&D (21.6) 41.5 11.2 7.2 11.9 12.2 4.0

Financial Expenses 46.4 (12.6) (39.0) (66.0) 21.2 9.1 8.1

CAPEX (HKD m) 3,000.0 1,600.0 2,242.5 2,093.3 2,849.5 2,600.0 1,800.0 1,800.0

Net Gearing (%) 65.4 57.7 62.7 62.0 65.6 66.5 61.7 56.1

Shipment (000 tonnes)

Linerboard 2,202 2,658 3,861 3,945 4,316 4,321 4,321 4,321

Medium 1,032 326 431 508 509 709 759 784

Whiteboard 414 176 519 437 425 575 575 575

Tissue Paper 0 0 0 10 48 150 355 391

Shipment YoY Change (%)

Linerboard 21 45 2 9 0 0 0

Medium (68) 32 18 0 39 7 3

Whiteboard (57) 195 (16) (3) 35 0 0

Tissue Paper 380 213 137 10

ASP (HK$)

Linerboard 4,055.0 3,543.3 3,410.0 3,355.4 3,145.5 3,271.3 3,369.5 3,470.5

Medium 3,749.0 3,291.4 3,146.2 3,045.3 3,039.3 3,160.9 3,255.7 3,353.4

Whiteboard 3,717.3 3,419.8 3,470.0 3,503.4 3,280.0 3,280.0 3,280.0 3,280.0

Tissue Paper 0 0 0 7,413.4 8,828.7 8,828.7 8,828.7 8,828.7

ASP YoY Change (%)

Linerboard (12.6) (3.8) (1.6) (6.3) 4.0 3.0 3.0

Medium (12.2) (4.4) (3.2) (0.2) 4.0 3.0 3.0

Whiteboard (8.0) 1.5 1.0 (6.4) 0 0 0

Tissue Paper 19.1 0 0 0

20

Margin improvement to drive net profit growth.

Tissue paper operations are a growth driver.

Capex is under control and gearing will come down.

Earnings forecast

LMP should deliver net profit growth of 14.5%/14.8%/3.8% in

2016E/2017E/2018E. The growth divers are (a) steady performance in the

packaging paper segment, (b) an increasing contribution from the tissue

paper segment, and (c) margin recovery.

We expect moderate growth in sales volume of packaging paper products for LMP of

7%/1%/0.4% in 2016-2018E, respectively. The volume growth will come from utiliza-

tion rate improvement and new capacity growth. LMP will start operations of its liner-

board PM19 in Q3 2016, with annual capacity of 400,000 tonnes. Packaging paper

types, including linerboard, corrugated medium and coated duplex board, still make up

most of LMP's product mix. In 2016, we expect LMP’s linerboard, and medium and

coated duplex board to account for 69.8%, 11.5%, 9% of its sales, respectively.

LMP’s packaging paper products are achieving net profit per tonne of around HK$470-

480 currently, compared to HK$428 in 2H 2015. Resilient product pricing and low OCC

costs are the reasons for the improvement in profitability. Given supply-side reform and

a more favourable supply/demand environment, the profitability of LMP’s packaging

paper operations is expected to hold up in the short and medium term.

LMP will expand its tissue paper capacity from 140,000 tonnes in 2015 to 355,000

tonnes by the end of 2016. After completing the expansion, LMP will become one of

the top five tissue paper companies in China in terms of capacity. LMP’s sales volume

for tissue paper is expected to reach 150,000 tonnes in 2016. LMP has cost ad-

vantages over the other domestic leaders because of its in-house power and steam

plants, internal pulp supply and better infrastructure.

Based on its current expansion plan, LMP’s tissue paper operations will account for

about 12% of total turnover in 2017, up from 1.3% in 2015. Apart from capacity expan-

sion expenses, there should not be significant marketing expenses associated with

brand and channel building as LMP will focus on the OEM market initially. In addition,

by leveraging its low cost production facilities, high end equipment and better econo-

mies of scale, we believe there is ample room for margins to expand.

Through capex reduction, LMP achieved positive cash flow in 2014-2015. Its net gear-

ing ratio will increase slightly in 2016 given the investment in its tissue paper opera-

tions. The Company’s strong cash flow generation capability will help to further reduce

its net gearing ratio, which remained relatively stable in 2015, increasing 4ppts to 66%.

Five production lines for tissue paper and containerboard are expected to be added in

2016 resulting in a capex budget of HK$2.6bn in 2016. This capex will be financed

mainly by internal resources. We maintain the view that LMP’s net debt-equity ratio is

expected to be contained at <70% in the medium to long term.

21

Figure 23: Earnings projection

Sources: Company Data, CGIS Research

Income Statement (HKDm) FY2014 FY2015 FY2016F FY2017F FY2018F Cash Flow Statement (HKDm) FY2014 FY2015 FY2016F FY2017F FY2018F

Revenue 17,099 17,616 20,239 22,711 23,624 Net Income 2,443 2,876 3,303 3,770 3,906

Growth yoy% 0.8% 3.0% 14.9% 12.2% 4.0% Depreciation & Amort. 820 858 944 1,004 1,064

Gross Profit 3,072 3,578 4,154 4,787 4,991 Change in Working Capital (241) 365 (732) (690) (255)

Growth yoy% 6.4% 16.5% 16.1% 15.2% 4.3% Cash from Ops. 3,021 4,098 3,516 4,085 4,716

Selling General & Admin Exp. (1,039) (1,114) (1,247) (1,400) (1,456) Capital Expenditure (2,093) (2,850) (2,600) (1,800) (1,800)

Others Operating Expenses/Items 0 0 0 0 0 Sale of Property, Plant, and Equipment - - - - -

Operating Income 2,033 2,464 2,907 3,387 3,535 Change in Investing Acitivities (241) (146) (548) (647) (756)

Growth yoy% n.a. 21.2% 18.0% 16.5% 4.4% Cash from Investing (2,335) (2,996) (3,148) (2,447) (2,556)

Interest Expense (214.6) (154.9) (166.3) (169.7) (173.1) Net increase in bank borrowings 21,937 20,439 300 300 300

Interest and Invest. Income

Income/(Loss) from Affiliates 0 0 0 0 0 Issuance of Common Stock 0 0 0 0 0

Other Non-Operating Inc. (Exp.) (35.5) 13.2 0 0 0 Common Dividends Paid (660) (739) (902) (1,082) (1,209)

Impairment of Goodwill 0 0 0 0 0 Special Dividend Paid - - - - -

Gain (Loss) On Sale Of Invest. 426 428 409 397 388 Other Financing Activities (576) (957) (512) (567) (583)

Gain (Loss) On Sale Of Assets Cash from Financing 20,701 18,742 (1,115) (1,350) (1,492)

Income Tax Expense (305) (418) (479) (550) (571)

Minority Int. in Earnings 0 0 0 0 0 Net Change in Cash 21,388 19,845 (747) 287 668

Net Income 1904 2332 2670 3064 3180

Growth yoy% (2.2%) 22.4% 14.5% 14.8% 3.8%

Balance Sheet (HKDm) FY2014 FY2015 FY2016F FY2017F FY2018F Ratios FY2014 FY2015 FY2016F FY2017F FY2018F

ASSETS Profitability

Cash And Equivalents 2,033 2,959 2,211 2,499 3,167 Return on Assets % 5.8% 6.6% 7.3% 7.9% 7.8%

Receivables 5,891 4,869 5,594 6,278 6,530 Return on Capital % 5.9% 6.7% 7.5% 8.3% 8.3%

Inventory 3,258 3,092 3,552 3,986 4,147 Return on Equity % 11.3% 13.4% 14.9% 15.9% 15.4%

Other Current Assets 35 122 113 115 117

Total Current Assets 11,217 11,042 11,471 12,878 13,961 Margin Analysis

Net Property, Plant & Equipment 22,465 23,351 25,007 25,802 26,538 Gross Margin % 18.0% 20.3% 20.5% 21.1% 21.1%

Long-term Investments - - - - - SG&A Margin % 6.1% 6.3% 6.2% 6.2% 6.2%

Other Intangibles - - - - - EBIT Margin % 11.9% 14.0% 14.4% 14.9% 15.0%

Deferred Tax Assets, LT - - - - - EBITDA Margin % 16.7% 18.9% 19.0% 19.3% 19.5%

Other Long-Term Assets 1,055 1,206 1,206 1,206 1,206 Net Income Margin % 11.1% 13.2% 13.2% 13.5% 13.5%

Goodwill - - - - -

Accounts Receivable Long-Term - - - - - Asset Turnover

Total Long Term Assets 23,520 24,557 26,213 27,009 27,744 Total Asset Turnover 0.5x 0.5x 0.5x 0.6x 0.6x

Total Assets 34,737 35,599 37,684 39,886 41,705 Fixed Asset Turnover 0.7x 0.7x 0.8x 0.8x 0.9x

Accounts Receivable Turnover 3.0x 3.3x 3.9x 3.8x 3.7x

LIABILITIES & EQUITY Inventory Turnover 5.2x 5.7x 5.7x 5.7x 5.7x

Accounts Payable 3,262 3,043 3,496 3,923 4,081

Accrued Exp. - - - - - Liquidity

Short-term Borrowings 6,698 5,250 5,250 5,250 5,250 Current Ratio 1.1x 1.3x 1.3x 1.4x 1.5x

Curr. Port. of LT Debt - - - - - Quick Ratio 0.8x 0.9x 0.9x 0.9x 1.0x

Curr. Income Taxes Payable - - - - - Avg. Days Sales Out. 125.8 100.9 100.9 100.9 100.9

Unearned Revenue, Current - - - - - Avg. Days Inventory Out. 69.5 64.1 64.1 64.1 64.1

Other Current Liabilities 357 156 155 170 187 Avg. Days Payable Out. 84.9 79.1 79.3 79.9 79.9

Total Current Liabilities 10,317 8,449 8,901 9,343 9,518 Avg. Cash Conversion Cycle 140.9 118.2 118.5 119.0 119.1

Long-Term Debt 6,163 9,012 9,312 9,612 9,912 Net Debt to Equity 62% 66% 67% 62% 56%

Def. Tax Liability, Non-Curr. 0 0 0 0 0

Other Non-Current Liabilities 780 902 902 902 902 Growth Over Prior Year

Total Liabilities 17,260 18,363 19,115 19,857 20,332 Total Revenue 0.8% 3.0% 14.9% 12.2% 4.0%

Common Stock 117 114 114 114 114 Net Income (2.2%) 22.4% 14.5% 14.8% 3.8%

Additional Paid In Capital - - - - - Payout Ratio % 35.1% 35.7% 37.0% 38.7% 38.8%

Retained Earnings 17,360 17,122 18,455 19,915 21,259

Treasury Stock

Comprehensive Inc. and Other - - - - -

Minority Interest 0 0 0 0 0

Total Equity 17,477 17,236 18,569 20,029 21,373

Total Liabilities And Equity 34,737 35,599 37,684 39,886 41,705

22

Stock currently trading below its historical average.

Rerating warranted.

Valuation

LMP is leading paper manufacturer with about a 10% market share of the domestic packag-

ing paper market. We expect the Company’s good product mix and favourable geographical

exposure to enable it to outperform its peers in terms of profitability and ROE. LMP has

kept its net gearing ratio at around 60% in the past five years, and we expect its leverage

ratio to remain under control going forward, given the limited number of projects in the pipe-

line. We believe its healthy balance sheet will provide the company with more options with

regards to sustaining its growth, such as investing in greenfield projects or acquiring other

production facilities, if necessary. At 10.1x 2016 PER, the stock is currently trading below

its seven-year historical average PER. Given the structural supply/demand improvement,

improvement in profitability and increasing exposure to the tissue paper segment, we be-

lieve that LMP warrants a re-rating and should trade above its historical average PER. We

also maintain the view that LMP is a solid industrial name with a recovery story. We are

initiating coverage on LMP with a BUY rating and a target price of HK$7.0 based on 12x

2016E PER (lower than the historical average of 12x and lower than average of its peers). .

Share price catalysts include details on the government’s target for capacity reduction in the

paper industry, the Company’s increasing expansion in the tissue paper segment, and new

investment development plans for both packaging and tissue paper production.

Figure 24: LMP’s PER trend

Sources: Bloomberg, CGIS Research estimates

0

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23

Figure 25: Peer Comparison

Sources: Bloomberg, Company, CGIS Research estimates for covered stocks ; *:Nine Dragons Paper’s financial year ended in June

Ticker Company

Price Market Cap 2016F 2017F 2018F 2016F 2017F 2018F 2015 2016F 2015 2016F 2015 2016F 2015 2016F

Lcy US$m x x x x x x x x % % % % % %

2689 HK Nine Dragons Paper 5.98 3596.5 10.3 9.4 8.2 8.1 7.3 6.8 0.9 0.9 5.7 5.6 1.6 2.9 1.4 1.62314 HK Lee & Man Paper 5.88 3453.3 10.1 8.8 8.5 10.4 9.1 8.6 1.6 1.4 13.4 14.9 6.6 7.3 3.1 3.71812 HK Shandong Chenming Paper 6.14 2077.4 n.a. n.a. n.a. n.a. n.a. n.a. 0.5 n.a. 6.6 n.a. 1.8 n.a. n.a. n.a.2002 HK China Sunshine Paper Hldgs 1.05 108.6 n.a. n.a. n.a. n.a. n.a. n.a. 0.5 n.a. 3.4 n.a. 0.7 n.a. 2.8 n.a.2268 HK Youyuan International Holdin 2.38 363.9 n.a. n.a. n.a. n.a. n.a. n.a. 1.0 n.a. 9.5 n.a. 5.5 n.a. 1.6 n.a.2320 HK Hop Fung Group Holdings Ltd 0.59 60.6 n.a. n.a. n.a. n.a. n.a. n.a. 0.3 n.a. 2.4 n.a. 1.7 n.a. 5.1 n.a.3366 HK Overseas Chinese Town Asia 2.67 224.5 n.a. n.a. n.a. n.a. n.a. n.a. 0.5 n.a. 8.5 n.a. 1.2 n.a. 5.1 n.a.1768 HK Bracell Ltd 1.62 714.4 n.a. n.a. n.a. n.a. n.a. n.a. 0.7 n.a. 5.4 n.a. 3.9 n.a. 2.5 n.a.3331 HK Vinda International Holdings 13.42 1966.0 22.4 18.1 16.1 13.9 11.8 10.2 2.7 2.2 6.3 9.7 2.5 4.6 0.7 1.21044 HK Hengan Intl Group Co Ltd 66.35 10373.6 18.3 17.4 16.7 11.7 11.2 10.9 4.6 4.2 23.1 23.9 9.9 11.7 3.2 3.4Average 16.9 14.8 13.7 11.5 10.4 9.6 1.4 2.6 8.7 16.2 3.8 7.9 3.0 2.7000488 CH Shandong Chenming Paper-A 8.55 2077.3 10.3 8.8 6.6 9.8 8.5 7.8 1.0 1.0 6.6 9.1 1.5 2.0 3.5 3.9002078 CH Shandong Sun Paper Industr-A 5.23 1983.2 15.9 13.0 9.2 7.7 6.7 6.0 1.9 1.7 10.7 12.9 3.5 n.a. n.a. n.a.600966 CH Shandong Bohui Paper Indu-A 3.58 715.4 n.a. n.a. n.a. n.a. n.a. n.a. 1.2 n.a. 1.0 n.a. 0.3 n.a. n.a. n.a.600308 CH Shandong Huatai Paper Co -A 5.33 930.3 n.a. n.a. n.a. n.a. n.a. n.a. 1.0 n.a. 1.0 n.a. 0.4 n.a. n.a. n.a.600963 CH Yueyang Forest & Paper Co -A 6.35 990.2 33.4 15.9 11.3 n.a. n.a. n.a. 1.3 n.a. -7.2 3.7 -1.8 n.a. n.a. n.a.600103 CH Fujian Qingshan Paper Inds-A 5.40 857.2 n.a. n.a. n.a. n.a. n.a. n.a. 5.3 n.a. -12.5 n.a. -3.6 n.a. 0.0 n.a.600567 CH Anhui Shanying Paper Ind-A 2.92 1644.3 n.a. n.a. n.a. n.a. n.a. n.a. 1.8 n.a. 3.5 n.a. 1.1 n.a. n.a. n.a.002067 CH Zhejiang Jingxing Paper -A 8.00 1308.3 n.a. n.a. n.a. n.a. n.a. n.a. 2.8 n.a. 0.4 n.a. 3.0 n.a. n.a. n.a.000815 CH Mcc Meili Paper Industry C-A 19.67 2044.4 n.a. n.a. n.a. n.a. n.a. n.a. 525.1 n.a. n.a. n.a. 13.0 n.a. n.a. n.a.002511 CH C&S Paper Co Ltd-A 17.06 1289.2 39.4 27.0 21.1 n.a. n.a. n.a. 3.5 3.2 3.7 7.4 2.5 3.8 n.a. 0.2Average 24.8 16.2 12.0 8.7 7.6 6.9 54.5 2.0 0.8 8.3 2.0 2.9 1.8 2.01904 TT Cheng Loong Corp 11.20 385.4 n.a. n.a. n.a. n.a. n.a. n.a. 0.6 n.a. 6.1 n.a. 1.2 n.a. n.a. n.a.IP US International Paper Co 42.75 17577.7 12.4 11.8 11.2 7.1 6.8 6.7 4.2 3.9 20.8 34.4 3.3 4.9 3.9 4.2STERV FH Stora Enso Oyj-R Shs 7.61 6750.5 10.5 9.9 9.4 6.7 6.6 6.4 1.1 1.0 15.4 10.8 6.3 n.a. n.a. 4.5UPM1V FH Upm-Kymmene Oyj 17.09 10092.5 11.8 12.3 12.2 6.0 6.1 6.1 1.2 1.1 11.9 9.5 6.9 n.a. n.a. 4.63863 JP Nippon Paper Industries Co L 1852.00 2102.2 12.6 12.5 11.7 8.7 8.7 8.7 0.5 0.5 5.1 3.9 0.2 n.a. n.a. 3.23880 JP Daio Paper Corp 1173.00 1710.5 13.2 12.2 n.a. n.a. n.a. n.a. 1.0 n.a. 10.0 n.a. 2.2 n.a. n.a. 0.9Average 12.1 11.7 11.1 7.1 7.1 7.0 1.4 1.6 11.6 13.6 3.3 4.9 3.9 3.5

PE EV/EBITDA P/B ROE ROA Div yield

24

Major risk factors

Significant economic slowdown. This could result from stricter-than-expected monetary

tightening policies in China. A slowdown in consumption and exports would weaken paper

demand. This could translate into high inventories and weaker-than-expected paper prices,

which would result in a further de-rating of the sector.

Expect less impact from foreign exchange movement going forward. RMB deprecia-

tion against the USD has a negative impact on LMP, as the weaker RMB means higher

costs for imported OCC. The company has started to accelerate the pace of shifting to do-

mestic OCC, given its improved quality and supply in recent years, as well as the price dis-

count to imported OCC. For LMP, the proportion of domestic OCC is expected to increase

to 50%/55%/60% in 2016E/2017E/2018E, respectively, from 45% in 2015. With their in-

creasing pricing power, the leading paper makers should be able to pass on any increase in

costs.

Good capital and financial management. Compared to other paper makers, LMP’s profit-

ability is less sensitive to changes in different input factors, thanks to its lower gearing ratio

and smaller sales volume.

Tissue paper operations. Given the excess tissue paper capacity in China, there is a

downside risk on profitability when sales are extended into other regions.

Soaring coal prices. A faster-than-expected surge in coal prices may squeeze paper mak-

ers’ gross margins. Furthermore, stronger coal prices would also put pressure on independ-

ent power producers (IPPs) to raise power tariffs, which would also have a negative impact

on paper producers’ earnings.

25

Company background

LMP is the second-largest containerboard manufacturer in China and was listed in Septem-ber 2003. Its main products are (1) packaging paper, including linerboard, and corrugated medium and coated duplex board, (2) pulp, and (3) tissue paper. The company expanded into the tissue paper industry in late 2014. LMP has four production bases in China – Guangdong (Dongguan and Hongmei), Jiangsu, Chongqing and Jiangxi. The Company’s packaging paper capacity is located mainly in the southern and eastern part of China and accounts for 54% and 27% of its total capacity, respectively. The Company has no expo-sure in northern China. To diversify its geographical exposure, LMP is planning to expand in overseas markets, and the first step is establishing production facilities in Vietnam. LMP has paper production capacity of 5.23m tonnes at present, and its paper machine (PM) in Vietnam, PM19, with annual capacity of 400ktpa of linerboard, is scheduled to begin official operations in Q3 2016.

LMP acquired two tissue paper production lines under construction in Chongqing from its controlling shareholder (Mr. Lee Wan Keung) for a consideration of HK$404m in Nov 2014. LMP currently has annual tissue paper capacity of 135,000 tonnes, which will increase to 355,000 tonnes by the end of 2016, based on the Company’s current expansion plan.

LMP produces mainly containerboard and coated duplex board using recycled paper or OCC as the main raw materials. Total sales in 2015 comprised linerboard (69.5%), corru-gated medium (11.5%), coated duplex board (9.5%), and others (6.2%).

Linerboard has the highest margin of the Company’s products. The margins of coated du-plex board used to be higher than those of linerboard, but they have dropped rapidly since 2012 because of oversupply. Tissue paper products also achieved high profitability in 2015.

Figure 26: Location of LMP’s Production Facilities.

Sources: Company Data, CGIS Research

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Appendix—Selected management profiles

Mr Raymond LEE Man Chun, Chairman and founder, is in charge of corporate planning

and investment projects. Mr Lee has over 21 years of operational experience in paper man-

ufacturing and is experienced in paper making formulas and product development. Mr Lee

was conferred an Honorary Degree of Doctor of Laws in 2014 and holds a Bachelor’s De-

gree in Applied Science from the University of British Columbia, Canada. He is currently

involved in a number of public engagements and has been awarded honorary citizenship of

Dongguan and reputational citizenship of Changshu. Mr Lee received the “Young Industrial-

ist Award of Hong Kong 2002” and was a “2003 Hong Kong Ten Outstanding Young Per-

sons Selection Awardee”. In 2011, Mr Lee was appointed Vice President of the China Pa-

per Association.

Mr Edmund LEE Man Bun, Chief Executive Officer, is responsible for production manage-

ment, sales, daily operations, research and development, repair and maintenance of pro-

duction machines, factory staff management, etc. Mr Lee holds a Bachelor’s Degree in Ap-

plied Science in Chemical Engineering from the University of British Columbia, Canada. He

is the younger brother of Mr Raymond LEE Man Chun.

Mr Ross LI King Wai, Executive Director, is responsible for the global procurement of re-covered paper, logistics planning and optimization, as well as external affairs for the Group. He holds a Master’s Degree in Science in Electrical Engineering from Stanford University, USA, and a Bachelor’s Degree in Applied Science in Computer Engineering from the Uni-versity of British Columbia, Canada. He has over 13 years’ experience in production man-agement and operations, and technological research and development. He is the brother-in-law of Mr Raymond LEE Man Chun and Mr LEE Man Bun, both of whom are Executive Directors of the Company.

Mr Henry CHEUNG Kwok Keung, Chief Financial Officer and Company Secretary, is re-sponsible for the internal supervision and management of the Group’s financial matters and investor relationships. Mr Cheung is a fellow of the Association of Chartered Certified Ac-countants and an associate member of the Hong Kong Institute of Certified Public Account-ants, and has over 26 years’ experience in the field of auditing, accounting and financial management. He is an independent non-executive director of the listed company China Aoyuan Property Group Limited. He joined the Lee and Man Paper in August 2002.

27

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BUY share price will increase by >20% within 12 months in absolute terms :

SELL share price will decrease by >20% within 12 months in absolute terms :

HOLD no clear catalyst, and downgraded from BUY pending clearer signal to reinstate BUY or further downgrade to outright SELL :