Brokers say buy Star Paper, target price of Rs 152

The report lists out several investment positives, these are below: -

“SPML has recently embarked upon a modernisation-cum-expansion plan, which will take capacity from 71,350 tpa to 100,000 tpa by FY06 end. This would entail a capex of approx Rs 850 million, to be funded through internal accruals (Rs 350 million) and debt (remaining). We expect the capacity expansion to lead to volume growth and help SPML post a 25% CAGR in earnings over FY05-07. The modernisation exercise would also help in debottlenecking and result in substantial cost savings.”

“SPML is installing a new 16 MW captive power plant, which will replace the current diesel generation set. The new plant is expected to be complete by CY05 end. This initiative will help SPML combat power costs in a rising fuel oil price scenario and also result in cost savings of over Rs 50 million per annum from FY07. The new captive power plant would entail a capex of Rs 480 million, most of which has already been incurred. The company is also installing a new turbine, a new multi-fuel boiler and will retrofit old turbines so as to make them work at high pressure. It is also increasing the capacity of recovery boilers."

“SPML is operationally one of the most efficient companies in the paper industry. Its FY05 net profit margin of 11.1% is better than those of peers West Coast and TNPL .To achieve this high NPM, the company cut raw material costs and its raw material cost as a percentage of turnover fell from 22.6% in FY01 to 15.7% in FY05. SPML also enjoys return ratios superior to those of peers. The FY05 RoCE was 30.9% and RoE 20.1%, higher than West Coast's and TNPL's. This operational efficiency will help SPML command higher valuations.”

“The market value of SPML's investments stands at a healthy Rs 38 per share against the current market price of Rs 96. We believe that this will cushion any substantial price erosion.”

“Another reason for the bullish outlook on demand is that the paper sector's fortunes are closely linked to the GDP growth; in fact, there is a 1:1 correlation between the two. The present UPA government is also committed to increasing the literacy levels. The budgetary allocation to increasing literacy stands at 6% of GDP and the education cess is at 2%; this will augment demand for paper going forward and boost the sector's fortunes.”

“The prices of most varieties in the W&P and industrial paper segments have been rising since mid-2004 on the back of stable demand and higher operating rates. Though the creamwove, maplitho and coated paper sub-segments of the W&P segment saw lower prices in FY04, prices of these sub-segments rose in FY05 on the back of rising demand and greater input costs. Most of the larger players were able to pass on the rise in input costs to the end users. The average prices for creamwove rose from Rs 32,546 per ton in June 2004 to Rs 37,000 in June 2005. Similarly, average prices for maplitho increased from Rs 36,057 per ton to Rs 38,250 over the same periods. In the industrial paper segment, the prices of duplex board, chromo board and wood-based kraft paper remained stable during in FY04 and rose in FY05. The average price of kraft paper (wood-based) rose from Rs 25,500 in June 2004 to Rs 29,250 in June 2005.”

“The main entry barriers are the highly capital intensive nature of the paper sector, shortage of raw materials like bagasse and the poor performance of paper companies in the past. The main deterrent is the high cost of setting up a plant. A new, integrated unit with captive power, in-house pulping facility and co-generation plant needs investment of Rs 75,000 per ton of paper output. Thus, the cost of a 50,000 tonne plant would be Rs 3.75 billion. Brownfield expansions by existing players are more viable, at Rs 25,000-30,000 per tonne of finished paper output. Imports are also not a practical idea since the consumer's requirement is of various sizes and grades of paper. A large inventory of different grades of paper over long periods would have to be maintained to meet this demand. The high freight costs entailed also don't encourage imports. Both these factors would increase the end user prices. Though the government has cut customs duty from 40.4% in FY02 to 20% in FY05, imports form only 3% of production.”

“In order to keep raw material prices in check, SPML has been continuously increasing the area under social forestry. Under this scheme, the company gives seedlings to the farmers to carry out plantations. There is no pact between SPML and the farmers, which would make it binding upon the farmer to sell back the wood to the company. However, we believe that this initiative would go a long way in ensuring a steady supply of wood in SPML plant's adjoining areas and also keep a lid on raw material prices. The company is also ensuring that more than the required number of trees is planted, so as to provide for growth in future. The company is also awaiting the government nod for captive plantations; such a move would make SPML cost-competitive globally.”

The report also mentioned some investment concerns, these are below: -

“Since paper is a commodity, its prices can be volatile affecting our estimated numbers. However, we believe that pricing power is returning to the sector and a reversal is not likely to happen in the near future.”

“Any delay in increasing the installed capacity can hamper the sales growth thereby depressing bottomline estimates.”

“Power constitutes a major component of input costs for paper manufacturers. Soaring oil prices might increase the power costs and create a margin squeeze. However, captive power generation would lessen the impact of soaring oil prices.”

“The company's entire manufacturing facilities are located at its Saharanpur plant. Any adverse event or calamity in the nearby areas could affect the production at the plant.”

About the company’s financials, the report says,

“SPML’s net profits show a CAGR of 33% over FY02-05 with the sales CAGR over the same period being 5.65%. The company has been able to achieve consistently high net profits due to high operational efficiency and prudent costs management. SPML also has a good dividend payment track record. Dividend per share rose from 50 paise in FY02 to Rs 1.75 in FY05.”

“The Q1 FY06 net profit fell 22% yoy due to a 50% rise in raw material costs. Moreover, there has been a Rs 28 million stock adjustment, which is expected to reverse in the coming quarters. The Q1 FY06 and Q1 FY05 results are not strictly comparable since in June 2005 modernisation/expansion was underway impacting production. The Q2 FY06 results are also not expected to be very good since there was a 20-day shutdown in the plant in July 2005. But we maintain that these are short term glitches and the FY07 results would be very good.”

About the company’s valuations, the report says, “At the current price of Rs 96, the stock trades at P/Es of 7x and 4.7x the FY06E and FY07E earnings. The EV/EBITDAs work out to 3.7x and 2.7x and P/BVs to 1.3x and 1x over the same periods. We arrive at a fair value of Rs 152, based on DCF valuation of core business plus value of investments. We recommend a Buy with a price target of Rs 152 over a 12-month horizon, implying an upside of 58% from the current levels.”

About the company’s itself, the report says,

“Star Paper Mills was incorporated in 1936 and is one of the oldest in the paper business. This G.P. Goenka group company is a niche player, concentrating on virgin kraft and industrial poster segments. The company enjoys one of the highest profit margins in the sector (FY05 NPM 11.1%) and its RoE and RoCE are better than those of peers like West Coast and TNPL. SPML has only one factory, at Saharanpur (in UP), with a capacity of 71,350 tonne per annum, tpa. The company has embarked upon modernisation-cum-expansion of its facility, which is slated to hike capacity about 40% to 100,000 tpa by FY06 end. This exercise is also expected to result in some cost savings. The company is among the leading players in north India and has a loyal clientele including Hindustan Lever, Shree Krishna Paper Mills, Mastercote, Century Laminating, Green Ply Laminates, and ITC. SPML's profits have grown at a CAGR of 33% over FY02-05. The company also has a good dividend payment track record. Dividend per share rose from 50 paise in FY02 to Rs1.75 in FY05. With almost all of its revenues coming from domestic sales, the company is well poised to benefit from an upturn in the paper cycle.”

“SPML manufactures cultural and industrial paper, with two-thirds of revenue coming from industrial paper. Demand for industrial paper accounts for around 50% of the total demand, with W&P and newsprint accounting for 33% and 17% respectively on an all India basis for the paper industry. Cultural paper comprises writing and printing paper as well as business communication paper. Industrial paper comprises absorbent kraft, padding paper, base paper, kraft paper, poster paper, poster ARSR and ribbed kraft paper. Key segments where the company has a strong position are wood based virgin kraft and industrial posters. SPML's share in these segments on an all India basis is around 60% and 16% respectively.”