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Not Out Of The Woods

There is little respite in sight for paper companies.
Rahul Oberoi/Money Today | Print Edition: December 2013
Not Out Of The Woods

Paper companies are not in the pink of health. Their shares, too, have been under huge pressure of late. The stocks of 25 paper manufacturing companies that trade on the Bombay Stock Exchange, or BSE, have fallen 22% on an average since January. They had returned 26% in 2012.

Ballarpur Industries, Rainbow Papers, Tamil Nadu Newsprint & Paper and JK Paper had fallen 44% 10%, 10% and 22%, respectively, this year till October 25. Among the big paper companies, Andhra Pradesh Paper Mills is the only one to have given some returns; it rose 4.5% to Rs 288.30 during the period.

One reason for the stress in the sector is the rising cost of raw materials such as pulp and coal. Global wood pulp prices rose 15% from $720 tonne (Wood Pulp Sweden) in October 2012 to $830 per tonne in September 2013. In India, rupee fall further pushed up prices. This year, the rupee has fallen 10.84%; it was at 61.50 on October 28 as against 54.83 on January 1.

"Paper companies have been struggling with rising prices of domestic wood and imported materials such as pulp and coal due to rupee depreciation. This has impacted their margins," says Chandan Sharma, senior analyst, corporate, India Ratings & Research.

To combat rising costs, paper companies increased prices by 5-8% in August and September. An India Ratings & Research report says this is unlikely to increase margins.

Gokul Raj P, executive director and head, investments, HBJ Capital Services, says, "Paper companies are unable to pass on increase in input cost to consumers, resulting in severe margin compression. Increasing prices beyond a point is not possible due to threat of imports. That is why the companies in the sector have been under pressure."

TORN APART

Most issues affecting paper companies are beyond the control of their managements and the structural problem of limited pricing power will continue to make sure that new issues keep cropping up. For instance, media companies' focus on digitisation has been hitting demand for paper for quite some time, a trend that is likely to continue and, maybe, strengthen.

Gokul Raj P says the sector is expected to remain subdued over the next two years.

Siddharth Rajpurohit, assistant vice president, fundamental analyst, The Market Financial Intelligence, differs a bit. "A stable growth rate of 4-6% is expected. At this rate, the industry will be able to absorb the capacities coming on stream over the next two years. However, the high cost of pulp and coal is a cause for concern," he says. If the rupee stabilises for a few months and then rises, the cost of imported inputs will fall, increasing margins. General and state elections over the next six-eight months will also boost demand. "We may see higher off-take, but increase in realisation is unlikely. However, the companies may see some improvement in profitability from the second half of 2013-14," says Rajpurohit.

FACTORS TO WATCH

The first thing you much see before investing in a paper company is if it can generate own power. If yes, you must see if it has a purchase agreement with Coal India so that its dependence on imported coal, which is 30-40% more expensive, is low. According to market experts, raw material and power account for 75% expenses of paper manufacturers.

Kishor P Ostwal, chairman and managing director, CNI Research, says, "You must check the company's ability to reduce raw material and labour costs."

Vikram Dhawan, director, Equentis Capital, says there are other cues as well. "The figures that may be considered are operating margins and debt-equity ratios. High margins and low debt-equity ratio will ensure decent profitability even if the current environment continues for longer than expected."



FINANCIAL HEALTH CARD

The top 15 paper companies on the basis of market capitalisation reported an average net profit margin of just 1.6% in the year ended March 2013.

During the period, profits of Rainbow Papers and Emami Papers rose 7.91% and 39%, respectively, to Rs 35.35 crore and Rs 11.55 crore, respectively, from the same period a year ago. JK Paper and Tamil Nadu Newsprint & Papers registered net profits of Rs 37.70 crore (down 24%) and Rs 91.48 crore (down 16%), respectively, during the period.

Experts are not very positive on the sector for 2013-14. "The industry is not out of the woods as global pulp prices are expected to remain high. Also, we do not expect much rupee appreciation in the near future. Hence, the profitability of paper companies is expected to remain under pressure in 2013-14," says Rajpurohit.

Chandan Sharma of India Ratings seconds Rajpurohit and says, "Large companies have taken steps to increase operational efficiency by building integrated pulp facilities and modernising equipment. These savings will be the key to higher profitability as cost and pricing pressures are unlikely to ease in 2013-14."

STOCKS YOU CAN BET ON

Ballarpur Industries (BILT):

The flagship company of the Avantha group is India's largest manufacturer of writing and printing paper. In 2007, the company acquired Malaysia's largest integrated pulp and paper mill, Sabah Forest Industries, for $261 million. The company is nearing the end of its expansion phase. The inhouse pulp capacity will ensure that it is not impacted by fluctuations in pulp prices globally.

On October 28, the stock was at Rs 12.63. "We expect the company to post decent numbers. Its operating profit margins are also expected to rise. At the 2013-14 expected earnings per share of Rs 3.56, the stock is trading at a price to earnings multiple of 3.5 times. We value the company at five times and have arrived at a target of 18 for the stock," says, Siddharth Rajpurohit of The Market Financial Intelligence.

WHY BUY: The company is nearing the end of its expansion phase and by the end of 2014 will have a capacity to produce 639 kilotonne per annum (ktpa) pulp and 1,134 ktpa paper. The in-house pulp capacity will ensure that it is not impacted by fluctuations in pulp prices

Tamil Nadu Newsprint & Papers (TNPL):


The company has been posting strong sales growth of 15% a year for the last three years. Its profitability has also remained strong. It has its own pulp facilities, which is why raw material costs are stable. Gokul Raj P of HBJ Capital says, "The company has been increasing capacity consistently. Its capacity utilisation is also higher than the industry average. This will continue in the near future."

The company has tied up with seven co-operative sugar mills in Tamil Nadu for supply of 10 lakh tonnes of bagasse in return for steam. This has resulted in savings of TNPL as its wood requirement is much less. This has turned out to be a game changer for the company and has helped it lower the cost of production, protecting margins even in a tough business environment.

Rajpurohit of The Market Financial Intelligence says, "We expect TNPL to post 30% growth in profitability in 2013-14. It has high operating profit margins and hence will trade at a premium. We have a target of Rs 111 for the stock."

Dhawan of Equentis expects 10%-15% upside in BILT and TNPL stocks in the short to medium term.

On October 28, the TNPL stock was at Rs 99.70.

WHY BUY: The company has been posting strong sales growth of 15% a year for the last three years. Its profitability has also remained strong. It has its own pulp facilities, which is why its raw material costs are stable. Its capacity utilisation is also higher than the industry average


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