Sector Update: Paper Industry - Kotak

We are upbeat on China's stringent regulation to curb pollution as it has further intensified production cuts spread across six regions. The production cut has helped the prices of various commodities (steel, chemicals, papers, to name few) to remain firm or see a sharp surge even in the lean season. The uptick in the prices in the domestic market is also supported by the rupee depreciation. In the paper industry, restrictions on using waste paper from China (imports of recovered paper declined 50% YoY during Jan-Jul'18), has supported the prices. Besides this, mills having capacity less than a 300KT/year, were forced to stop import of waste paper.

Key highlights:

- China has extended the duration of production cuts during the winter by two months starting from Oct 1 till Mar 31 next year in 28 cities. This compares to the last year period from 15 Nov 17 to 15 Mar 18.

- China witnessed the permanent closure of smaller non-compliant domestic mills using non-wood or recovered fibres. During FY18, capacities close to 300KT/year were shut down in China due to lack of environmental compliance.

- China has also restricted and delayed annual import licenses for domestic companies that receive wastepaper as a commodity for recycling. China is the world's largest importer of waste paper, with import volume of more than 60% of the global trade. Top 3 players in China account for 21% market share.

- China has substantially raised its import of pulp, leading to a spike in pulp prices. Pulp is a substitute for waste paper and its major exporters -Indonesia, Malaysia, Chile - have diverted theirs to China at a higher price.

- We believe that, given the high cost curve globally coupled with rupee depreciation, Indian paper industry should do well in the near term. Besides, this having access to raw material (wood and waste paper) at competitive rates and no new capacity coming on stream in the near term, shall support the earnings of industry players.

Outlook

Increasing demand from China for high quality product or intermediate items for finished products and rupee depreciation, has led to shift in focus of various domestic players in the paper industry to the lucrative export market, thereby creating paucity in the domestic market. This has resulted in a sharp surge in paper prices. Besides this, increasing cost curve globally has also supported the final product prices (China imported pulp prices increased by ~29% YoY during Jan-Jul'18 to average of US$797/tonne). We believe the benefit of the higher paper prices will reflect with a lag of 2-3 months and all the paper companies are likely to remain under focus for the near term, as 3QFY19E number should reflect the benefit of the uptick in the commodity prices. Paper industry in the domestic market will also benefit from consolidation (as per industry, around 20 companies have stressed balance sheet and operating at sub-optimal capacity); and possible imposition of anti-dumping duty

Source : Equity Bulls

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