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Industry Risk Score

Punjab National Bank July 2016

Paper - Industrial

Introduction Contents
Industry Risk Score (IRS) reflects the impact of industry variables on
the cash flows and debt repayment ability of the companies in the
industry over 3-4 years. The risk score for an industry is arrived at, by
Executive summary 3
aggregating the scores assigned to the parameters relevant for the
industry. Background 4

Industry parameters include variables such as demand-supply


outlook, cost structures, competition and financial performance. The Industry risk parameters 5
parameters are selected based on the extent to which they affect the
debt-servicing ability of the companies operating in the industry. Demand-supply 5
Scores on these parameters reflect the extent of positive/negative
impact on cash flows, and the degree of variability in cash flows of the
companies. Government policies 5

The industry risk scores have been graded on a seven-point scale, Input-related risk 5
with 1 indicating high risk and 7 indicating low risk.

Extent of competition 6
Risk score Risk factors
6.01 - 7.00 Highly favourable Financial risk 6
4.51 - 6.00 Favourable
4.01 - 4.50 Marginally favourable Annexure 7

3.01 - 4.00 Neutral


2.51 - 3.00 Marginally unfavourable
1.01 - 2.50 Unfavourable
0.00 - 1.00 Highly unfavourable
PAPER - INDUSTRIAL

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Last updated: April 2016

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Executive summary

Demand for industrial paper is expected to grow at a CAGR of about 7.5 per cent between 2015-16 and
2020-21, as compared to around 5 per cent CAGR over the past five years, as the economic activities pick
up gradually. The key input for industrial paper players is wastepaper. Domestic wastepaper meets about
65-70 per cent of wastepaper requirement and the remaining is met through imports. In 2016-17 we expect
international wastepaper prices to fall by around 6 per cent y-o-y, primarily on account of expected subdued
demand from countries like China following slower economic growth. This will result in moderate 50-150 bps
rise in profitability margins for the players. In 2017-18, while the international wastepaper prices are
expected to remain stable, domestic wastepaper prices are expected to witness an increase. Despite this,
margins are expected to remain stable owing to anticipated rise in realisations during the year following
strong demand in the domestic market.

Parameter Weightage Score


Paper - Industrial: Industry risk score 2.99
Industry characteristics 85 3.15
Demand-supply gap 35 3.50
Government policy 10 3.50
Input-related risk 25 3.50
Extent of competition 30 2.33
Industry financials 15 2.05
Operating margin of industry 35 2.63
RoCE of industry 65 1.75
Source: CRISIL Research

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PAPER - INDUSTRIAL

Background

The industrial paper segment is highly fragmented as compared to the W&P paper segment. Industrial
paper can be sub-classified into tertiary packaging (kraft paper), consumer packaging (duplex/ recycled
boards - greyback and whiteback, and virgin boards - folding box board/ solid bleached board (FBB/SBB). In
2015-16, industrial paper demand constituted about 47 per cent of overall paper demand. Within industrial
paper, tertiary packaging paper (kraft paper) accounted for around 57 per cent, recycled boards accounted
for 32 per cent and virgin boards accounted for the remaining 11 per cent.

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Industry risk parameters

Demand - Supply

In 2016-17 and 2017-18, demand is expected to improve by about 7 per cent CAGR, primarily on account of
improvement in economic activity and rising demand for consumer goods. The growth would largely be driven
by revival in demand from key end-user industries such as FMCG, Retailing, consumer durables etc.
Moreover, rapidly rising penetration e-Commerce and organized retailing will further boost the demand over
the long term. On the supply front, growth in capacity addition will be slower than growth in demand, thereby
resulting into gradual improvement in operating rates from 77-78 currently to 82-83 till 2020-21.

Government policies

There are no direct government policies that influence the industrial paper market. Even as far as the duties
are concerned, there is no major impact as demand is largely met indigenously due to specific packaging
needs of customers and high level of customisation. Hence, government policies relating to import duties do
not affect the industrial paper segment to a large extent. The import duty on wastepaper under FTA
agreement for ASEAN countries remain zero.

Input - related risk

The key input for industrial paper players is wastepaper. Domestic wastepaper meets about 65-70 per cent of
wastepaper requirement and 30-35 per cent is imported. This high proportion of Imports in raw material mix is
due to low recovery rates in India (less than 30 per cent as compared to about 65 per cent rate in developed
market), given its highly fragmented mechanism. Since India imports a high proportion of waste paper, prices
are subject to volatility in the international prices and currency exchange rates. In 2016, global waste paper
prices are expected to decline by about 2-7 per cent to average $190-$200 per tonne due to falling demand
from China. China, with about 36 per cent share, is the world's largest consumer of recovered paper (RCP)
and with import contributing to about 35-40 per cent.Sharp fall in global wastepaper prices will put pressure on
domestic waste paper prices, which are expected to fall by 2 per cent during the year.

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PAPER - INDUSTRIAL

Extent of Competition
The domestic paper industry is highly fragmented with more than 700 paper mills with a majority of them in
the paperboard segment.The top 10 players in this segment account for only approximately 15 per cent of
total volumes produced. However, some of these players operate in the high value added segments (such as
virgin boards and recycled boards), which are relatively consolidated and enjoy better pricing flexibility.
Smaller players, which account for majority of the production, usually operate in the kraft paper (tertiary
packaging) segment. This segment is highly fragmented and players are exposed to the changes in the
economic cycle.Imports do not account for a significant portion in this segment, as the level of customisation
is high and the orders placed do not justify the demand for foreign players to export.

Financial Risk
Paper - Industrial: Financial parameters
Select Financial
Unit Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15
parameters
Rs
Aggregate turnover 11447 10846 13258 13919 14873 15346 18017
million
Operating profit margin Per cent 10.1 10.7 9.4 6.2 7.8 6.9 8
Return on capital
Per cent 12.3 12.8 10.9 6.5 8.5 6.1 9.5
employed
Net profit margin Per cent 3.2 4.5 3.5 0.2 1.3 0.7 0.9
Return on equity Per cent 10.9 13.2 11.2 0.6 4.8 2.4 3.8
Interest coverage ratio Times 3.3 3.8 3.9 2.5 3.1 3 2.6
Debt-equity ratio Times 1 0.8 1 1 1 1.2 1.2
Current ratio Times 1.5 1.4 1.6 1.4 1.4 1.3 1.3
Assets turnover ratio Times 1.4 1.3 1.5 1.5 1.6 1.5 1.3
Raw materials days Days 49 54 46 43 43 43 46
WIP holding days Days 3 3 3 3 4 3 3
Finished goods days Days 10 7 8 8 6 7 8
Debtors days Days 33 33 32 35 37 38 36
Creditors days Days 72 88 61 73 89 94 98
Nos. of companies No 5 5 5 5 5 5 5
Source: CRISIL Research

Paper - Industrial: Cost aggregates


Cost Structure (% of net Sales) Unit Mar-09 Mar-10 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15
Raw material cost Per cent 56.9 58.4 61.7 63.6 58 59.6 59.5
Power and fuel cost Per cent 18.3 16.6 16 16.7 20.1 19.3 18.3
Other operating costs Per cent 5 4.7 4 4.2 3.9 4 3.9
Employee cost Per cent 6.5 6.3 5.7 5.7 6 6.1 6.5
Selling cost Per cent 3.3 3.4 3.1 3.6 4.1 4 3.8
Nos. of companies No 5 5 5 5 5 5 5

Source: CRISIL Research

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Annexure

Companies used for calculating sector aggregates

N R Agarwal Inds. Ltd.,Ruchira Papers Ltd.,Shree Ajit Pulp & Paper Ltd.,South India Paper Mills Ltd.,Star Paper Mills Ltd.

These companies constitute around 8 per cent of the market.

Paper - Industrial - Sector Aggregate - Interim results


% of % of % of % of
Jan-Mar Jan-Mar Apr-Mar Apr-Mar
(Figures in Rs Million) net net net net
2015-16 2014-15 2015-16 2014-15
Sales Sales Sales Sales
Net sales 4573.7 100 % 5171.8 100 % 19106.5 100 % 19767 100 %
Total Operating exp 5185.9 113 % 4718.3 91 % 19510 102 % 17679.7 89 %
Raw Material exp 3151.5 69 % 2766.3 53 % 11997.9 63 % 10932.5 55 %
Purchase of Finished goods 34.8 1% 412.6 8% 514.2 3% 1209.6 6%
Change in stock 88.7 2% 22.6 0% 309.2 2% -113.7 -1 %
Salaries and wages 299 7% 299.6 6% 1219.1 6% 1096.9 6%
Power & Fuel 47.1 1% 55 1% 193.5 1% 262.2 1%
Rent & lease rent 0 0% 0 0% 0 0% 0 0%
Selling & distribution expenses 32 1% 29.9 1% 80.5 0% 68.2 0%
Other expenses 1532.8 34 % 1132.3 22 % 5195.6 27 % 4224 21 %
OPBDIT -612.2 -13 % 453.5 9% -403.5 -2 % 2087.3 11 %
Depreciation 1204.9 26 % 189.1 4% 1806.9 9% 775.1 4%
OPBIT -1817.1 -40 % 264.4 5% -2210.4 -12 % 1312.2 7%
Interest 775.6 17 % 311.7 6% 1812.9 9% 1244 6%
OPBT -2592.7 -57 % -47.3 -1 % -4023.3 -21 % 68.2 0%
Other Income 16.5 0% 56.3 1% 102.7 1% 159 1%
Non-op Income 0 0% 0 0% 0 0% 0 0%
Extraordinary Income/Expenses -182.5 -4 % -34.4 -1 % 240.6 1% -32.4 0%
PBT -2758.7 -60 % -25.4 0% -3680 -19 % 194.8 1%
Total Tax 528.2 12 % -28.6 -1 % 1071.7 6% 138.8 1%
Current tax 365.9 8% 143.2 3% 570 3% 336.2 2%
Deferred tax 255.4 6% -186.6 -4 % 255.4 1% -186.6 -1 %
FBT 0 0% 0 0% 0 0% 0 0%
Net profit -3286.9 -72 % 3.2 0% -4751.7 -25 % 56 0%
Nos. of companies 5 5 5 5

Companies included in interim sector aggregate


N R Agarwal Inds.; Ltd.; Rainbow Papers Ltd.; Ruchira Papers Ltd.; South India Paper Mills Ltd.; Sree Sakthi Paper Mills Ltd.

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PAPER - INDUSTRIAL

Paper - Industrial - Business risk evaluation

Risk entity name Weightages


Operating Efficiency 80
Capacity Utilization 35
Being a capital intensive segment of the paper industry, capital costs for the players forms
about 15 per cent of the overall operating expenses. Higher capacity utilization helps spread
fixed costs better, thus positively impacting profitability for the players. (asset turnover ratio of
about 1.2)
Availiability of Raw Materials 35
Raw materials costs account for about 60 per cent of the total cost. Availability of wastepaper
is a major risk to operations and profitability.
Energy Cost 20
Energy costs account for about 15 per cent of the operating costs. Availability of captive
power plant and/or captive coal can provide significant upside to profitability.
Management of Price Volatility 10
Competition is high in the domestic market due to high level of fragmentation. Import from
Asian countries have increased due to 'nil' duty regime under the Indo-ASEAN Free Trade
Agreement. As a result, prices of industrial paper are expected to remain volatile.

Market Position 20
Size Related Pricing Advantages 10
Industrial paper is fragmented with the top 15 players accounting for only 15 per cent of the
market. These players enjoy a certain level of pricing flexibility.
Proximity to Market 30
Players, having production facilities closer to the consuming hubs, have better access to
marketplace and cost advantage in terms of reduced freight cost and lead time. Accordingly,
majority of the consumption is local in nature (depending on variety required).
Financial Ability to Withstand Price Competition 35
Increase in raw material prices during phases of low demand tend to lower the profitability of
players as they are not able to pass-on the rise in costs further. The companies, which have
the ability to absorb prices, are at a lower risk of going out of business.
Product Range 25
The product range varies like kraft paper (esp. for industrial applications) and duplex paper
(mainly for consumer applications). Even within these categories, product range varies
significantly as per the quality (BF) which has different applications. The diversification across
product range helps to mitigate slowdown in a segment or application. For instance, ITC is
present across kraft, duplex
Source: CRISIL Research

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