Neha Dave Moneycontrol Research
Highlights: - Profitability of paper companies on an uptrend - IPAPPM well placed to take advantage of the growth in paper industry - Stellar operating and financial performance - High margin looks sustainable - Valuations reasonable despite run-up in the stock
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India is the fastest growing market for paper globally and is expected to grow over six percent per annum over the next few years. With an estimated domestic turnover of about Rs 50,000 crore, it accounts for about three percent of the world’s paper production. This presents an exciting scenario as paper consumption is poised for a big leap forward in sync with economic growth.
Paper companies turned around sharply in FY17 and their profitability is on an uptrend. H1 FY19 earnings of paper companies reaffirmed the growth momentum. While JK Paper remains our top pick in the sector, we delved further to identify another paper company that benefits from an upturn in the sector. After all, a rising tide lifts all boats. We have been extremely selective, preferring leading players and/or companies with strong financials and parentage.
We have zeroed on International Paper APPM (IPAPPM), which has a strong global parent and a long-standing 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. We are enthused by the fact that it derives its revenue from sale of both paper and pulp and has de-risked its business by being an integrated manufacturer. A reasonable valuations makes it worthy of consideration.
Formerly known as The Andhra Pradesh Paper Mills, IPAPPM has total installed capacity of 2,41,000 metric tonne per annum (mtpa) and two production facilities in Andhra Pradesh. In its first significant domestic acquisition by a foreign paper company, International Paper – a US based global player, bought 75 percent stake in the company, following which it was renamed IPAPPM.
Strong financial performance IPAPPM reported stellar operating and financial performance with a three-fold jump in its net profit to Rs 83 crore in H1 FY19.
Supported by higher capacity utilisation IPAPPM’s capacity utilisation for finished paper improved to 95 percent in FY18 (90 percent in FY17) on account of enhanced productivity. Consequently, its production volume increased by a healthy six percent to 2,28,900 MT in FY18.
Improved profitability margin IPAPPM’s EBITDA margin improved 930 bps in H1 FY19 to 24 percent in comparison on the back of favourable selling price, lower cost of raw material and improved operational efficiencies. A significant fall in interest charges added to the company’s profitability.
IPAPPM’s performance has been good so far. But the moot question is: Will it sustain? We think so.
Despite its plant running at 95 percent utilisation, IPAPPM has not announced any capacity expansion plans. So, future sales growth is dependent only on realisation growth and operating efficiency. We see both realisations and cost scenarios remaining favourable in the near term, thereby supporting its high margin.
Realisations likely to remain buoyant A significant increase in global pulp prices and a resultant increase in global paper prices has improved realisations for IPAPPM. International pulp prices, the key raw material continued to inch up till September-end, pushing up paper prices. While there has been mild moderation in October, global pulp prices are expected to remain firm in the medium term.
One factor that is expected to keep global pulp prices elevated is the environmental restrictions by the Chinese government on imports of low grade recovered/waste paper. 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 paper prices.
Given the positive domestic demand-supply scenario, we believe paper realisations will sustain at current levels, though some instances of rising imports at predatory prices from surplus countries was seen. To address this concern, DGAD (the Directorate General of Anti-Dumping and Allied Duties) in early December recommended the imposition of anti-dumping duty on imports of uncoated paper from Indonesia, Thailand and Singapore for a period of three years. This move is set to protect domestic players by supporting their margins.
While global pulp prices have been rising over the period, it is worth noting that lower dependence on imports along with high usage of captive wood has resulted in reduced input costs for IPAPPM, aiding margin. For instance, while the raw materials cost of waste paper increased 4 percent, it was offset by the lower price of hardwood procured domestically, which fell 7 percent in FY18.
Valuations reasonable despite the run-up in the stock price Thanks to improved financials and strong earnings growth, the IPAPPM stock has outperformed, delivering around 38 percent return in the last one year. Since a large part of the valuation re-rating seems to have played out, upside in the near term will be driven by earnings growth. Valuation re-rating can play out in the medium to long term given that the stock is currently trading at a reasonable valuation (5 times FY20 estimated EV/EBITDA). Sectoral opportunities also offer strong earnings visibility and a good reason to buy the stock.
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