After graphite stocks it’s paper stocks that are benefiting from China factor
Paper Industry has seen good turnaround over the last one year after four years of painful situation. Paper companies have reported double digit earnings growth over the last few quarters led by revival in domestic demand. In addition their balance sheets look lighter with reduced debt burden and improved leverage ratios. Yet, these changes do not seem to fully reflect in their valuations. However, the industry is seeing few positive triggers such as shut down of capacities in China and likely imposition of anti-dumping duty on cheaper paper imports in India. We believe these factors will lead to further improve in earnings growth thereby increase in valuations.
Paper and Pulp industry is coming out of dismal phase:
Global Paper and pulp Industry is coming out of its dismal phase after nearly two decades. Recent developments like ban on low grade waste paper in China, Wood Pulp supply disruptions in Chile and Changing pattern of paper use will lead to increased demand for Virgin grade pulp and paper (Natural Fiber based paper) in the world.
China’s ban on mixed waste paper is leading to rise in paper prices:
China is the largest importer of waste paper and pulp in the world. Recently, China has stopped imports of several grades of waste paper as a part of campaign against foreign garbage, which has created shortage of raw material and impacted the paper production. Further capacities close to 3 lakh tonnes per annum are shut down due to lack of environmental compliance. As a result, packaging paper prices, for instance, have shot up by 40 per cent to over 5,500 yuan per tonne since. The recent ban along with the reduction in pulp supply from Chile (meeting 10% of Chinese wood pulp need), has big implication on global demand and supply.
Rise in Pulp and Paper prices in the world
Anti-dumping duty on cheaper imports will benefit domestic players:
In the second week of November 17, India has initiated an anti- dumping probe into imports of a certain kind of paper from Indonesia, Thailand and Singapore following complaints from some domestic companies. In the probe, it would determine the existence and effect of the alleged dumping and recommend the amount of anti- dumping duty, which if levied, would be adequate to remove the injury to the domestic industry. The duty is aimed at ensuring fair trading practices and creating a level-playing field for domestic producers vis-a- vis foreign producers and exporters. We expect the government to impose 10-15% anti-dumping duty on cheap paper imports. We believe this will be the significant positive trigger for all the paper stocks.
The rise in pulp and paper prices will impact the Indian Paper industry positively:
In terms of market size (~₹530bn, as per our Estimates), currently the Indian Paper Industry is equally divided between Recycle and Natural fiber based paper. The natural Fiber manufacturers will be benefited with the diversion of wood pulp from ASEAN countries to China and Western Europe leading to improving their pricing power on the other hand demand for quality packaging paper and board may increase as demand from China may flow to India. The Indian paper industry is expecting an increase in the prices of pulp and paper in the coming months in line with the increase in global prices
Three paper companies to bet on rising paper prices:
The increase in pulp and paper prices will help the domestic companies in increasing their realizations. Currently the Natural fiber production cost for the Indian Manufacturers have remained in the range of Rs.30-32/Kg yielding a gross margin of ~Rs.27/Kg. Among the listed players, we like TNPL, West Coast Paper Mills and Seshasayee Paper & Boards Ltd. All the companies are trading at single digit earnings multiples. The increased realizations due to rise in paper prices and reduced debt levels (low interest cost), will lead to high growth in earnings for these companies.
Tamil Nadu Newsprint & Paper Ltd:
With 600000 ton of total operational paper capacity TNPL is the largest independent paper company in India. The company is one of the most integrated paper mills in the country with average plant cost at Rs 75000/ton. The company manufactures paper from wood and bagasse procured from nearby Sugar mills. The cost of production of pulp by the company is one of the lowest in the world (Wood and Bagasse cost @ Rs.6.5/kg). It also manufactures board from waste paper. With firm raw material sourcing in place we expect the company will remain the key beneficiary in the industry up move. The softness in international waste paper prices will bode well for the recently commissioned paper board capacity of the company.
In FY17 the company put up its paper board capacity of 200000 tons. Since beginning of FY18 the company could not utilize its facility due to want of water. Now as per the media reports the company is operating its facility fully. Being a quality paper board manufacturer the company may participate in export from this facility with the rise in prices in the international market. The stock is trading at attractive multiple of 8x FY19E earnings and 1.2x FY19E BV. At CMP of Rs.424 the stock provides valuation comfort and further the stock gave a dividend yield of close of 2%.
West Coast Paper Mills Ltd:
West Coast Paper Mills is one of the leading paper producing company with operational capacity of 320000 ton per annum. Company sources its majority of raw materials from domestic market and remaining from imports. Company’s balance sheet has improved significantly over the last two years. The debt has decreased from Rs.910cr in FY15 to Rs.499cr at the end of FY17. We expect further reduction in debt going forward. With the reduced interest cost and improved margins due to increased realizations we expect strong earnings growth for the company. Currently, At the CMP of Rs.320 the stock is trading at 10x its FY18E earnings and has 3yr average OCF yield of 13.7%.
Seshasayee Paper and Boards Ltd.:
Seshasayee Paper has operational capacity of 187000 tons per annum and running at its full capacity. Company’s performance has improved significantly over the last few quarters with improved margins. During Q2FY18, The operating margin has increased to 21.2%, from 16.7% in Q1FY18. The company faced water problems for its plant in the past, however situation has reversed now. Balance sheet strength has increased significantly over the last two years. The debt has reduced from Rs.329cr in FY15 to Rs.177cr in FY17. The current debt/Equity ratio stands at 0.32x and expect it to reduce father going forward. The stock is currently trading at 7.8x its FY18E earnings and 1.5x FY18E books value. The stock also has good dividend yield of 1.2%