Paper's buoyant demand to continue: Icra

The rising demand will also get support from growth in print media (particularly in vernacular languages)

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Increasing literacy levels coupled with higher government spending on education sector is set to keep long term demand outlook for the Indian paper industry favourable with overall demand rate to grow between 6-8%, a study conducted by the rating agency Icra said.

The rising demand will also get support from the growth in print media (particularly in the vernacular languages) and change urban lifestyles as well as economic growth, it added.

Given that these factors are likely to be sustained, the paper industry is likely to continue growing in the medium to long term although there maybe aberrant years given the cyclical nature of the industry. In addition, the preparation for general elections will provide further fillip to paper demand in FY14.

According to Icra, the low per capita consumption of paper provides tremendous potential for growth in paper demand. Further the capacity addition programme has now come to an end and there has been a considerable slowdown in new project announcement and completion.

With the recent capacity additions coming to completion any fresh announcements is unlikely in the near term and with gestation period of 24-30 months for new capacities, supply side pressures have started easing.

The industry is expected to see around 0.35 million tonnes of new capacity during FY14 and around 0.3 million tonnes in the next year (as against current capacity of around 13 million tonnes).

Assuming a moderate growth of 6%, the market would expand by around 0.7 million tonnes annually which would be sufficient to absorb the new capacities that will come up in the next 2-3 years.

However, the favourable demand-supply dynamics may not immediately translate into higher profits for paper companies. The cost for most of the key inputs is currently at a very high level and domestic coal and wood prices are still increasing at a rapid pace.

The ability of the companies to pass on these costs will remain the key to profitability. Companies with better cost and capital structures and a diversified portfolio of products would be better placed to endure the pressures in the medium term.

The paper industry reported robust growth in revenues during FY08-FY13 driven by steady growth in consumption levels and increase in realisations. This period also saw steady increase in the cost of inputs such as wood, chemicals, coal etc.

Over-supply scenario, rising cost pressures and increasing competitive pressures from imports made it increasingly difficult for the paper mills to pass on these cost increases. As a result, the operating profitability of the industry came under pressure in FY12.

According to Icra’s sample study, the average operating margins of the companies declined from 21.96% in FY08 to 15.87% in FY13. Though pricing flexibility has improved marginally with an improvement in demand-supply dynamics, the profitability of paper mills continues to remain under pressure due to rising costs of raw material, coal and chemicals.

Further, high depreciation and interest costs on account of debt funded capital expenditure undertaken by the industry have resulted in pressure on net profitability of paper companies as reflected by decline in net profitability from 11.34% in FY08 to 1.44% in FY13 for companies.

The funding of capacity expansion projects through bank borrowings led to increase in gearing levels of paper companies from the lows of FY06. High gearing levels (in the range of 2-3 times as on March 31, 2012) coupled with decline in profitability has put pressure on the debt coverage indicators of the industry.