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Structural re-rating continues
Earnings improvement in terms of both quantity and quality
In 2009, sales growth in the paper sector will likely slow on weaker
demand amid the global economic slowdown. But we expect domestic
paper makers will gain pricing power during the sector’s restructuring
and raw material (pulp and waste paper) prices will likely fall faster than
anticipated. As such, we expect the operating margins at Korea’s three
main paper makers – Hankuk Paper, Hansol Paper and Moorim Paper
– to rise from 7.6% in 2008 to 8.6% in 2009F. Earnings volatility will
likely dwindle as their ability to cope with raw material price changes
gets stronger.
Transition to a seller’s market helps the industry’s turnaround
The supply glut, a major nuisance for the paper industry, was eased on
the facility shutdowns of white duplex board in 2006 and printing &
writing paper in 2007. The effects of the facility closures materialized in
earnest beginning in 2H07. As the raw material price pass-through to
the product prices became available, the paper industry started to make
a turnaround. In 2009, the average pulp prices are expected to fall 20%,
but paper prices will not likely fall in tandem given the voluntary
restructuring of laggards and further sector-wide restructuring such as
Hansol Paper’s takeover of EN Paper.
Earnings sensitivity differs by company
Earnings sensitivity on the KRW/USD rate varies depending on how
heavily a company relies on exports for its sales and how large its
foreign currency-denominated debt holding is. For the pulp prices, the
earnings sensitivity differs by the pulp input ratio for the paper
production according to the product mix. If the KRW depreciates, the
prime beneficiary will be Moorim Paper whose dependence on exports
is the heaviest among peers. Its operating profit will grow 2% on every
1% rise in the KRW/USD rate. If the KRW strengthens and the pulp
price falls, it should benefit Hankuk Paper the most given its least
reliance on exports and highest pulp input ratio. Its operating profit
should increase 4.4% or 8.8% if the KRW/USD rate and the pulp prices
fall 1% respectively.
Top pick: Hankuk Paper
We present Hankuk Paper (002300, BUY, TP W43,000) as our sector
top pick. The counter became the dominant player with a copy paper
market share of 50% thanks to an annual uncoated wood-free paper
capacity addition of 170,000 tonnes in early 2006. Although the
slumping economy weighs on demand, the company will be defensive
to weaker demand given that uncoated wood-free paper is in short
supply. We expect its earnings momentum will be the largest if USD
pulp prices fall as the company is more exposed to pulp purchasing
than competitors. In addition, given its low net debt-to-equity ratio of
48% as of end-3Q08, the company is financially solid.
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