Paper stocks see strong investor interest as biz cycle turns favourable

Improving demand and likely consolidation in the industry are key triggers

The paper industry has seen a recent surge of investment interest. Part of this is a natural consequence of investments in the packaging industry, which is doing well. Investors expect the paper cycle to also remain strong as a result.

However, unlike in the packaging sector, the financial position is less clear in the paper industry. Approximately 20-25 per cent of the revenues of the paper industry are generated by listed companies, with the rest coming from smaller mills.

In Q4, 2020-21, a sample of 21 listed companies saw their revenues up 16 per cent year-on-year at Rs 5,244 crore versus Rs 4,520 crore in Q4, 2019-20.  Operating Profits were up 19 per cent YoY at Rs 949 crore vs Rs 797 crore a year ago. Profits after tax were down 5 per cent at Rs 427 crore versus Rs 450 crore. Tax paid was up 241 per cent at Rs 156 crore versus Rs 46 crore. Financing and interest costs were down 29 per cent at Rs 115 crore.

The higher revenues are a good sign but this hasn’t translated into profits. The industry had to cope with demand destruction in some segments due to schools and colleges being shut down. It also had to survive supply chain issues apart from coping with production during lockdowns, so this is actually a decent performance.

In the last fiscal, supply of waste paper for recycling dried up due to lack of transport facilities with the shipping industry hit by global lockdowns. China also became a big buyer of waste paper and pulp, pre-empting supply to Indian mills.

India depends on waste paper pulp imports for close to 65 per cent of all raw material supply. This is especially important for the packaging industry. This is due to the fact that the US/ Europe have per capita paper consumptions of about 55-60 Kg/ year versus India’s per capita consumption of 15 Kgs.

One reason for long-term optimism is that per capita consumption is expected to grow in India from this extremely low base. The industry is hoping for better demand as educational institutions re-open. Bans on plastics could also be a driver since paper is a natural replacement in many cases. As such, long-term growth in paper consumption is around 6-7 per cent CAGR in India, whereas demand for paper is flat in the First World.

The industry is expected to start consolidating. Larger, financially stronger players are likely to take over capacity as under-capitalised smaller mills cannot find the resources to upgrade technology. The top three listed players in India account for about 10 per cent market share whereas they hold 20 per cent in China and around 65 per cent in the US. So, a trend of consolidation is likely.

Economies of scale are considerable in the industry since it’s a commodity. It’s a capital-intensive industry with high fixed assets and working capital requirements. The industry could also face competition from big international players who might explore the possibility of opening production facilities within India. There may however, be scope to increase efficiencies all along the value chain.

Last week, most paper company shares surged towards new 52-week highs. The gainers included Pudumjee Paper Products, Star Paper Mills, Orient Paper, Seshasayee, JK Paper, Tamil Nadu Newsprint, and West Coast Paper. It’s a highly cyclical industry but the cycle could be favourable, especially for listed companies if the consolidation trend takes hold.