Jan 19, 2013, 01.16 PM | Source: Equitymaster.com
This is the fifth article in our series that analyzes some expensive stocks in specific sectors to understand if their valuations or 'high PE' (price to earnings) multiples are justified.
In the first article of the series we looked at PE food stocks, in the second, we discussed high PE steel stocks, in the third article of the series we examined auto stocks trading at high PE multiples and in the fourth we analysed high PE fertiliser stocks.
In today's article, we will analyse the paper stocks with highest PEs and try and find the reasons for the same.
From a list of more than 50 paper companies, we identified three with the highest PEs, (in descending PE order) as West Coast Paper Mills (West Coast), Rainbow Papers (Rainbow) and Ballarpur Industries (BILT).
Let's look more closely at the reasons for the relatively strong PEs of these companies.
Key financial parameters for 3 highest PE Paper stocks
|Average growth (in %)|
|Average Profit Margins (in %)|
|Return on Equity (in%)||18.4||20.4||12|
Note: Numbers are for last 10 years except TTM PE.
TTM: Trailing Twelve Month
West Coast Paper Mills was established in 1955 and is one of the oldest manufacturers of paper for printing, writing and packaging in the country. With its wide variety of papers, it caters to the requirements of industries as diverse as garments, stationery to food packaging. The paper and paperboard plant is located in Dandeli, Karnataka. The company uses Eucalyptus, Casuarina, Subabul and other Hardwood as a raw material. West Coast is also involved in the business of telecommunication cables which it manufactures at its Mysore plant. The company exports its products to Malaysia, Egypt, Middle East, Kenya, Indonesia, Fiji, Mauritius and Greece, amongst others.
The 10 year average annual sales growth has been 14%. However the company was unable to maintain this level in net profits which have grown by just 5% on an average during the same period. The growth has been quite volatile for the paper company. Average debt to equity has been high at 1.5 times and stood at more than 2 times in the latest year. Operating profit margin has been close to 16% on an average and net profit margin has been comparatively quite low at just 7.3%. The stock is currently trading at 24 times its trailing twelve month earnings which does not seem justified as per its financials.
Rainbow Papers started its operations in the year 1981 and is one of the fastest growing companies in the paper sector. Its product range includes around 186 different varieties of paper aimed at domestic sales as well as exports. Main offerings are uncoated woodfree paper, newsprint, paper board, kraft paper, coated paper and speciality paper. Also, the company has recently ventured into office stationery segment. Globally, Rainbow's products are available in various countries in the US, Middle East, South Africa, South East Asia and the UK. The annual production capacity stands at 3,05,000 m tonne. One distinct feature of the company is its focus on green initiatives in the form of making bricks from fly ash, manufacturing boards from sludge and manufacturing laminate sheets.
Sales of Rainbow Papers have grown by 20.6% on an average in the last decade and has been more or less consistent. However, the net profits grew by 74.5% during the same period because of huge jumps in 2003 and 2006 on account of lower bases in both years. Average operating profit margins hovered around 16% and net profit margins around 5%. Both are witnessing an increasing trend except for the latest year. Average RoE has been 20.4%, however the same has been close to 15% in recent years. Historically, average debt to equity was 2 times. The same stood at 1.77 times for the latest financial year. The stock is trading at 17.5 times its trailing twelve month earnings which is high for paper companies.
BILT is the largest manufacturer of writing and printing paper in India. The company is managed by the Thapar family. It has 7 manufacturing facilities; six in India and one in Malaysia. BILT recently got into office stationery business and started manufacturing paper tissues too. The recent acquisition of Sabah Forest Industries has helped BILT get access to the South East and East Asian markets. The paper company has in the recent past carried out business restructuring to make its business model simpler for the interest of investors.
BILT's 10 year average sales growth has been rather low at just 13.6% and quite volatile too. Net profits grew by 11.8% on an average during the last decade. In terms of profit margins, operating profit averaged around 21.8% and been very stable while net profits have been close to 7%. Average RoE has been only 11.8%. Current debt to equity ratio is 1.93 and historically too it has been quite high at an average of around 1.5 times. Industry PE of paper is 10 times and BILT being the market leader in paper sector may demand some premium in valuations. However, the stock is trading at 13 times its trailing twelve month earnings which is relatively high for conservative paper stocks that grow in line with the country's GDP.
Conclusion: The demand drivers of the paper sector are all dependent on the growth in the economy. Hence, in times of recent economic downturn, the industry too slowed down. The demand would go up with revival in the economy and associated user industries. While there is a lot of scope for growth of paper companies in the long run, the prices at which the above mentioned stocks are trading seem overvalued. Also, the valuations are higher than the industry average of 10 times trailing twelve month earnings.
Equitymaster.com is India's leading independent equity research initiative