– Paper sector benefits from positive demand-supply scenario
– Realisations likely to hold up
– Significant capacity additions lined up
– Integrated players with self-sufficiency in major inputs best placed
– JK Paper best positioned within the sector
India is the fastest growing market for paper globally and is expected to grow at more than six percent per annum over the next few years. This opens up an opportunity for investors.
Paper companies turned around sharply in FY17 and the sustained improvement in their financials continued in the third quarter of FY19 as well. Their superior financial performance was reflected in the stock prices which have seen a strong rally in past few years. For instance, the JK Paper stock has generated a compounded annual return (CAGR) of around 50 percent in the last 3 years.
The moot question is: will the superior performance of paper companies and their stock prices continue? Let’s look at the factors that will determine the future profitability of the sector.
India’s paper sector has grown to 17.1 million tonne in FY18 from 9.3 MT in FY08, a compounded annual growth rate (CAGR) of 6.3 percent. Paper demand is likely to remain buoyant due to increased demand from the FMCG and packaged food segment as well as rapidly growing e-commerce (the likes of Amazon and Flipkart). At the same time, supply remains constrained following the closure of stressed domestic capacities such as Ballarpur Industries (BILT).
In short, the demand-supply gap is likely to remain favourable in the near to medium term.
Could the recent news of the paper sector attracting the highest ever FDI of around Rs 24,000 crore significantly alter demand-supply dynamics in future? Read: Paper sector gets largest FDI ever; should the Street cheer?
Asia Pulp & Paper (APP), an Indonesian paper company, has signed a Memorandum of Understanding (MoU) with The Andhra Pradesh Economic Development Board (APEDB) for setting up India’s largest paper mill in a single site with a staggering 5 MT per annum (mtpa) capacity in Andhra Pradesh. However, it will take a long time for the capacity to come on stream.
The improved performance of paper companies is also due to better realisations, driven by high input cost. International pulp prices, a key raw material continued to inch up till September-end, pushing up paper prices in turn. While there has been a mild moderation in the third quarter of FY19, global pulp prices are expected to remain firm in the medium term.
Environmental restrictions by the Chinese government on imports of low grade recovered paper are expected to keep global pulp prices elevated. China, the largest importer of waste paper globally, announced a ban on certain grades of waste paper in July 2017, which came into force in January 2018. The move led to increased demand for pulp, pushing up global pulp prices and consequently global paper prices.
Which paper companies should be on investors’ radar?
Companies that can quickly expand their existing capacity and have well integrated operations stand to benefit from the current upcycle. These two factors are the key differentiators that will drive the future profitability of paper companies.
The paper sector in India has not added any significant capacities over the last three to four years. As a result, most paper companies are currently operating at around 85-90 percent levels of capacity utilisation, while the larger companies are operating at over 100 percent.
Source: Care Ratings
Paper companies stand to benefit from sectoral uptrend – which one should you pick up?
Consequently, significant investments have been lined up for expansion in production capacity, the bulk of which are in the packaging paper & board segment, as a high growth rate is anticipated in this segment. The majority of recently announced capacity expenditure (capex) plans are scheduled for completion after April 2020.
Strong raw material sourcing capabilities
An integrated player with sufficiency in all major inputs – raw material (pulp), water and power will be able to sustain and improve margin.
Paper stocks have outperformed on the back of improving financials and strong earnings growth. While some part of the valuation re-rating seems to have played out, tailwinds in the sector provide strong earnings visibility.
Tamil Nadu Newsprint & Papers (TNPL), the second largest player in the paper sector, has ample scope of margin improvement as it is operating at 16 percent EBITDA margin, compared to over 25 percent for most large peers. However, TNPL’s input costs are extremely volatile as it has sizeable dependence on imported pulp for its newly commissioned unit. In the past, water availability has been an issue for TNPL.
Another interesting paper company is International Paper APPM (IPAPPM) which enjoys strong global parentage and a track record of more than five decades in the Indian paper industry. Its diversified product-mix and various initiatives ensuring raw material self-sufficiency are comforting. However, despite operating at around 95 percent utilisation level, IPAPPM has not announced significant capacity expansion plans.
JK Paper is best positioned within the sector due to its strong market position and presence in high quality paper segments, established brand name, cost leadership and integrated production capacities.
JK Paper stands out as it sources more than 80 percent of its wood requirements from captive farm forestry. Additionally, adequate water is available at both of its units in Gujarat and Odisha and it has also achieved self-sufficiency in power.
Moreover, JK Paper is expected to see meaningful increase in production resulting from its acquisition of Sirpur Paper Mills. Part of Sirpur’s total capacity of around 1,38,000 tonne per annum (tpa) is expected to come on stream in the first quarter of FY20 on completion of refurbishment of the existing plant. This will give JK Paper a relative advantage vis-a-vis peers. That could translate into more upside for its stock.
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Disclaimer: Moneycontrol Research analysts do not hold positions in the companies discussed here