Why paper industry is not liked by many investors Ft Andhra Paper

Established in 1921 as “Carnatic Paper Mills”, Andhra Paper is engaged in the business of manufacturing paper, pulp and paper boards. The company produces a wide range of premium grade writing, copier, printing and industrial papers for domestic as well as export markets. 

Since its operations in 1921, the company has witnessed multiple ownerships wherein 2011, the Company was acquired by International Paper (IP), IP is a USD 23 billion American pulp and paper manufacturing company from then promoter LN Bangur. IP acquired a 75% stake in the company for around INR 19 Bn (approx. INR 474 per share). 

Meanwhile, In 2019, the controlling stake in the Company was acquired from IP by West Coast Paper Mills Ltd. West Coast acquired a 55% stake in the company from IP for INR 6 Bn (approx. INR 274 per share) and another 17.2% through an open offer for INR 3 Bn (approx. INR 438 per share).

But before diving any deeper, we need to understand how the Indian paper industry functions and why it is not talked about among the investors community.

The paper industry?

The Indian paper industry comprises Container Boards (Used as packaging material), Carton board (Lightweight and used for shipping thin and light packages like DVD), Writing and Printing, Newsprint and Specialty papers. Now, the writing and printing segment is the one where Andhra Paper accounts for ~22% volume of the industry. 

But, the Indian paper industry is highly unorganized and fragmented with top 3 players accounting for just 9% market share with small units accounting for more than 60% of the industry. This is quite opposite in more developed economies like Indonesia, USA where bigger players account for more than 70% of the market and China where such big players account for 21% of the industry. Also, China is the largest producer (28% share) and consumer (27% share) of paper products followed by the USA. India accounts for 4% of the global production and 5% of the global consumption of paper products. The per capita consumption of paper in India is approx 13 Kg, way behind the global average of 57 Kg.

Where do we get our raw materials from?

In India, wood pulp accounts for 30% of the raw materials used for producing paper. But due to limited availability of wood fiber in India, we are bound to use waste paper and this accounts for 50% of the raw material while the remaining 20% comes from agro residue. The mills are dependent on imports for the high quality production of paper.

Why is the paper industry not much in talks?

The Indian paper industry added a significant capacity in the first half of the decade (2011-2015) and this led to the over capacity. But with limited supply of raw materials, the prices started to inflate and due to the over capacity and low demand, the producers were unable to pass the price increase to consumers thus leading the mills to face a loss. 

Now, post 2015, the bigger players became cautious with their expansion plans and chose to grow inorganically via acquisitions. Before the COVID reign, India had 861 paper mills in the country of which only 497 were operational, depicting the stress in the industry even before the pandemic. Though, the bigger players have strengthened their balance sheets in the past five years and are in a better position to pursue inorganic expansion and secure greater economies of scale.  

What led to such an improvement?

Due to the limited availability of wood, China used waste paper as a major source of raw material to produce paper products. Prior to 2018, China accounted for almost 60% of global trade of waste paper but post 2018, China shut down the import of mixed grade waste paper, leading to the shutting down of a number of small paper mills due to non compliance issues.

China also changed the import licensing regulations to prevent paper mills below 50,000 tonnes per annum capacity from applying for import permits of recovered paper. As demand from China for waste paper declined, the prices globally for waste paper fell, and as mills in China shifted to wood chips, prices for wood pulp rose. The rise in wood pulp prices led to an increase in the final paper product prices.

But Indian mills that imported waste paper as a raw material benefited a lot from this as they were able to gain benefit from the prices of finished products as well. The bigger players that had plantations also benefited a lot from the increased end product prices and further increased their margins.

But most of the things changed in COVID!

So during lockdown, all the business activities were at a halt which led the paper industry to contract 15%. While the packaging paper segment registered a marginal growth of 2% due to the demand from the E commerce and pharma sector. While, the writing and printing segment contracted by 40% due to the closure of schools and colleges. Meanwhile the shipping costs were at a rise and the lower availability of waste paper led to a significant rise in cost of raw materials. 

Also, since China had banned import of waste paper, therefore Chinese companies imported Kraft paper from India. Kraft paper is turned into pulp which in turn is used to make high quality papers. This led to a steep rise in export of Kraft paper from India with zero volume in FY18 to 2 tonnes in FY21 which is around 20% of Kraft paper’s production. This huge export led to a shortage of raw materials in India and therefore a steep price rise. 

Back to Andhra Paper:      

The company has two manufacturing facilities- One at Rajahmundry with an average capacity of 506 tonnes per day to manufacture finished products while the other one is at Kadiyam with an average capacity of 257 tonnes per day. The Mill at Rajahmundry uses Casuarina, Eucalyptus or Subabul wood, while the other one at Kadiyam uses recycled fibre and purchased pulp to produce paper products. Not only this but the company has a very successful farm forestry program which helps them generate more wood than they consume.The company produces a maximum amount of raw materials needs within the 300 km radius of its mills with almost 37% of the raw materials being procured within a 150 km radius of the mill. The company further expects to improve this number to a staggering 51% by 2026.  

The major cost of any paper mill is its raw materials (pulp and chemicals). By reducing the procurement distance, the company has been able to save a lot on its raw material costs. While the company has been able to reduce its raw materials costs, the labor costs have been rising for the mill. In the past five years too, there have been a lot of incidents of labor strikes.

Conclusion:

The fluctuating prices with change in the demand and supply dynamics makes the paper industry extremely volatile. The industry ended FY19 with high inventories, and the contraction in demand in FY20, caused the pulp prices to fall. With the opening up of the economy, the industry is bound to be back on its track but the swinging fear of recession makes it still tough to manage their bottom lines. The paper industry globally has contracted in the developed economies and covid has only accelerated that move. Asian economies like China and India, are the major markets still showing growth in paper demand, with rising populations, improved access to education and move towards more sustainable packaging solutions.

In India, most of the recent capacity expansion announced has been towards Kraft paper and are being brought in to fulfill the rising demand internally and from China. Among the larger players, JK Paper has announced capacity expansion of 170,000 mt. For packaging boards, Seshasayee is upgrading their machines which will increase their paper production capacity by 35,000 tn/yr, and Satia industries is expanding their writing and paper capacity by 100,000 tn/yr.

Andhra Paper is mainly focussed in the Writing and printing segment, but the management has indicated that they are looking at the packaging segment as a “growth opportunity” for the company. West Coast is already present in the packaging segment and the management feels they have the expertise to guide Andhra Pradesh as well. Andhra Paper is in a much stronger position financially, and has generated significant free cash flows in the last five years, allowing them to retire most of their debt.

The company’s mills are in a great location- with easy access to coal and water, as well as the largest farm forestry programme in the country spread over 265,000 hectares (4,066 hectares within a 150 km radius to the mills), with a cumulative 1.8 bn saplings planted till FY21. This puts the company on great footing to expand their operations from here, as well as deal with any downturn in the industry.