Paper Sector - Industry on the Cusp of a Turnaround - Emkay

- Industry has been on capex mode for the last 4-5 years, leading to higher competitive intensity and lower pricing power in the hands of the manufacturers

- Capacity additions have been funded through a mix of debt and internal cash generation, which have led to a rise in debt

- Intensity of capacity additions has been higher than the previous cycle. Players analyzed by us have reported a 1.7x increase in capacity over FY08-14 compared with 1.2x during FY03-08

- Increase in raw material prices, due to limited availability and inflexible supply, has impacted EBITDA margins. EBITDA margins for the peer set analyzed by us shrunk from 23.4% in FY08 to 15.9% in FY13

- Capacity addition intensity is expected to decline significantly in the next 2-3 years, as no new large capacity additions are expected

- Reducing competitive intensity and continued absorption of excess capacity have helped players significantly pass on cost-push pressures in CY13

- Structural growth factors supporting domestic consumption remain intact, as the industry is expected to benefit from increasing per capita consumption in the medium term and higher demand due to general elections in the near term

- High operating leverage to lead to direct flow of benefit of higher average realizations to the bottom-line, improving cashflow generation, improved margins and de-leveraging of the balance sheet

- TNPL to benefit the most due to cost leadership, along with BILT, which is likely to benefit from higher operating leverage

- Valuations for TNPL (40% discunt to book value) and BILT (60% discount to BV) are close to the down-cycle troughs. Strong dividend yield at 4-5% coushins the downside risk

- Further increase in paper prices will lead to earnings upgrade going forward as we have not modeled for further price increase in FY15.

Source : Equity Bulls

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