China Paper Sector 13 December 2018abc 2 China Paper Sector P2UBS-S Research THESIS MAP a guide to our thinking and what's where in this report PIVOTAL QUESTIONS Q: Will China’s paper market face oversupply over the next two yearsYes, we expect a slight oversupply in the next two years, with around 4.5mt of net containerboardcapacity added in 2019E, or around 7.9% of total containerboard capacity by end-2018E. Demandgrowth could soften from 5.2%/2.3% in 2017/2018E to 1.8% in 2019E, mainly due to weakerpaper procurement sentiment resulting from US-China trade tensions as well as weaker GDPgrowth, according to UBS economists' forecasts. more Q: Will China’s paper industry consolidate furtherYes. We remain positive on the industry's consolidation momentum as smaller/obsolete paper millswill be under pressure due to higher costs, including fibre costs and other cash costs such as energyand chemical costs. UBS Evidence Lab: will stricter environmental control lead to less supply 20/07/2018Q: Will Rmb depreciation significantly erode the leading Chinese paper producers' earningsNo, the impact of Rmb depreciation should be limited. Our sensitivity analysis suggests that every1% Rmb depreciation against the USD and the euro would lower NDP/LMP's FY19/2019 reportedearnings by 4.7%/2.8%, while the impact on NDP's adjusted earnings could be -2.0%. moreUBS-S VIEW We are turning conservative on China's paper sector due to: 1) weaker-than-expected demand andpoorer sentiment on paper procurement; and 2) around 4.5mtpa of net containerboard capacityadditions in 2019E, accounting for 7.9% of total capacity by end-2018E. We downgrade NDP andLMP from Buy to Neutral despite undemanding valuations. There may be short-term risks as wehead into the weak season. EVIDENCE On the supply side, based on our checks with industry experts, we estimate total grosscontainerboard capacity additions of around 5.5/2.3mtpa in 2019/2020 and around 1.0/1.0mtpa ofcontainerboard capacity could be closed in 2019/2020, resulting in net containerboard additions of4.5/1.3mtpa in 2019E/2020E.WHAT'S PRICED IN NDP is trading close to its historical average PE since September 2015 as FX is a concern since Chinaadjusted the Rmb to the USD exchange rate in August 2015. NDP is trading 0.4 SD below itshistorical average P/BV since 2012. LMP is trading close to its historical average PE/PBV since 2012,justified by potential ROE erosion in the next 1-2 years. We think China's paper sector is fairlyvalued. more China containerboard supply and demand dynamics Source: RISI, UBS-S estimates 80.0% 82.0% 84.0% 86.0% 88.0% 90.0% 92.0% 94.0% 0 10 20 30 40 50 60 70 20112012201320142015201620172018E2019E2020E Total containerboard capacity (LHS)Total containerboard demand (LHS) Total Containerboard utilization rate (RHS) mt China Paper Sector 13 December 2018abc 3China Paper Sector UBS-S Research Sector Q1PIVOTAL QUESTIONS return Q: Will China’s paper market face oversupply overthe next two yearsUBS-S VIEWYes, we expect slight oversupply in the next two years, with around 4.5mt ofnet containerboard capacity added in 2019E, or around 7.9% of totalcontainerboard capacity by end-2018E. Demand growth could soften from5.2%/2.3% in 2017/2018E to 1.8% in 2019E, mainly due to weaker paperprocurement sentiment resulting from US-China trade tensions as well asweaker GDP growth, according to UBS economists' forecasts.EVIDENCEChina’s packaging paperboard demand is mainly driven by economic growthand consumer expenditure. UBS China economists forecast China's 2019/2020GDP growth at 6.1%/6% YoY, down from 6.9%/6.5% in 2017/2018E. UBSeconomists also forecast 7.0%/6.6% growth for China's consumerexpenditure in 2019/2020 (7.5%/7.2% in 2017/2018E). China's express delivery industry is maintaining decent growth, with volumeup 27% in 10M18. Our logistics analysts forecast an industry volume CAGR of25% in 2018-20, which does not factor in a potential economic slowdown. On the supply side, based on our checks with industry experts, we estimate2019/2020 total gross containerboard capacity additions of ~5.5/2.3mtpa andaround 1.0/1.0mtpa of containerboard capacity could be closed, resulting innet containerboard additions of 4.5/1.3mtpa in 2019/2020, accounting for7.9%/2.1% of capacity by the end of 2018/2019. WHAT'S PRICED INWe think the sector's supply and demand dynamics are shifting slightly tooversupply due to weaker demand and capacity additions in the next twoyears. However, any easing in US-China trade tensions could provide potentialupside to demand. We raise our 2019/2020 China containerboard capacity forecasts by 4.1%/2.9%based on our checks with industry experts, and we lower our 2019/2020 Chinacontainerboard demand estimates by 3.5%/5.3% given slower expected GDPgrowth and consumer expenditure growth. We also lower our net importassumptions by 49.4%/54.4% for 2019/2020 as we expect China'scontainerboard ASP to soften, leading to lower import volume. Thus, we cut ourChina containerboard utilisation rate estimates by 4.3ppt/4.5ppt for 2019/2020.The details of our supply and demand model and forecast revisions are as follows.Figure 2: China containerboard paper sector—supply/demand modelSource:RISI, UBS-S estimatesOldNewDifferenceOldNewDifferenceOldNewDifference Containerboard capacity (mt)56.156.20.3%58.360.74.1%60.362.02.9% Containerboard demand (mt)53.052.1-1.6%55.053.1-3.5%57.054.0-5.3% Containerboard net imports (mt)2.42.40.7%3.01.5-49.4%3.31.5-54.4% Containerboard utilization90.2%88.4%-1.79ppt89.2%84.9%-4.30ppt89.2%84.7%-4.48ppt 2020E2018E2019EChina Paper Sector 13 December 2018abc 4Figure 3: China containerboard paper sector—supply/demand model forecast revisionsChina2011 2012 2013 2014 2015 2016 2017 2018E 2019E 2020ECapacity (mt) Containerboard capacity 45.9 48.3 50.1 51.9 51.2 51.8 53.6 56.2 60.7 62.0Gross new additions 5.0 5.0 3.9 4.1 3.2 3.1 3.5 2.9 5.5 2.3Containerboard closures -2.1 -2.6 -2.1 -2.3 -3.9 -2.5 -1.7 -0.3 -1.0 -1.0Net new additions 2.9 2.3 1.8 1.8 -0.7 0.6 1.8 2.7 4.5 1.3YoY Growth 6.6% 5.1% 3.8% 3.6% -1.4% 1.2% 3.4% 5.0% 7.9% 2.1% Supply (mt)Production Containerboard 40.1 42.1 43.4 45.2 46.1 47.8 49.4 49.7 51.6 52.5 YoY growth 6.9% 5.0% 3.1% 4.0% 2.0% 3.9% 3.3% 0.6% 3.7% 1.9% Utilisation Containerboard87.3% 87.2% 86.7% 87.0% 90.0% 92.4% 92.2% 88.4% 84.9% 84.7% Net imports Containerboard 0.9 0.7 0.5 0.5 0.5 0.6 1.5 2.4 1.5 1.5 YoY growth 17.7% -20.2% -27.5% -6.4% -3.2% 19.8% 168.4% 55.3% -37.5% 0.0% Supply Containerboard41.0 42.8 43.9 45.6 46.5 48.4 50.9 52.1 53.1 54.0 YoY growth 7.1% 4.5% 2.5% 3.9% 2.0% 4.0% 5.2% 2.3% 1.8% 1.8% Demand (mt)Apparent consumption Containerboard 41.0 42.8 43.9 45.6 46.5 48.4 50.9 52.1 53.1 54.0 YoY growth 7.1% 4.5% 2.5% 3.9% 2.0% 4.0% 5.2% 2.3% 1.8% 1.8%Source:RISI, UBS-S estimatesSupply side: capacity additions are still on the wayWe expect around 2.7/4.5/1.3mt of net containerboard capacity additions in2018/2019/2020, accounting for 5.0%/7.9%/2.1% of total containerboardcapacity by end-2017/2018/2019.。。。。。。