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You could call this the paper industry’s inflection point, with the potential to generate some outstanding winners over the next few months. But for that to be explained cogently, one would need to go into a bit of history.
A few years ago, the paper industry, considered polluting, was required to clean its act requiring a landmark investment in environment equipment and asset modernisation. When analysts saw this, they baulked for a number of reasons: huge business investment, higher gearing and investment into some non-productive assets (environment for instance). As a result, shareholders began to foresee a decline in return ratios and quietly sold their stock.
There is a simple evidence to prove this: Sirpur Paper has commissioned nearly 1,37,000 tonnes per annum of paper and pulp capacity in addition to an 18 MW captive power plant. The total gross block of the company as on 31 March was around Rs 315 crore, the last modernisationcum-expansion cost Rs 430 crore, nearly 60% of the company’s asset base is new, the company is now positioned to generate annual revenues of Rs 475 crore—and its market capitalisation is but Rs 120 crore. That’s right, only around Rs 120 crore.
Interestingly, this is what Sirpur has done with the investment:
• Invested in a new fibre line with continuous manufacturing process. Benefit: reduced raw material consumption, lower chemical use, lower waste, enriched pulp quality and consistency, enhanced brightness and higher realisations.
• Cleaner manufacturing process with chlorine dioxide being used over the hazardous chlorine; besides, the re-burning and re-use of lime waste as well as a significant increase in steam water evaporation efficiency.
There is another factor that will strengthen the company’s economics: it will produce a larger quantity of pulp and paper at almost identical overheads, enabling it to cover its fixed costs more effectively. Besides, it will now be in a position to export its products to countries hitherto closed to it on account of chlorine use.
The company has also capitalised on a decline in excise duty from 12% to 8% in the recent Budget by retaining its price line, translating into enhanced earnings by more than Rs 1,000 per tonne, which could add a clean Rs 10 per share at earnings before interest, taxes, depreciation and amortisation (EBITDA) level.
So what does one make of the company’s earnings potential? There are some critical variables to consider: one, the company’s production is presently at around 280 tonnes per day compared to an installed capacity of 350 tonnes as it struggles to achieve operational stability. Two, there has been a sharp increase in chemical costs, which need to be countered.
Keeping all factors in mind, a conservative annual sales number of Rs 450 crore and a 22% EBITDA margin can generate nearly Rs 100 crore in EBITDA. Compare that with the market capitalisation that is only 20% higher and you have an out and out bargain on your hands.
Patherya heads Trisys, an annual reports consultancy. His column identifies stocks that are not in the limelight He can be reached at mudar@trisyscom.com
