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  • No paper tigers: How Indian paper stocks can gain from China

    Publish Date: September 28, 2018

    As many as 1.8 million people in China died as a result of environmental pollution in 2015 alone. Air pollution is a menace in the most populous country in the world, and finally China is doing something about it. The authorities there have come out with stringent regulations to curb the menace. The measures include intensified production cuts across many regions. All this is good for paper, and Indian paper firms.

    The supply curbs have helped the prices of various commodities, including paper, to hold fort or even surge in an otherwise laidback season. This has positive implications for Indian paper companies, who will enjoy the benefit of the higher paper prices, albeit with a lag. Besides, a possible imposition of anti-dumping duty can strengthen their investment case.

    Chinese checkers

    China has extended the duration of production cuts in winter by two months, starting from October until March next year, in 28 cities. Earlier, this was from 15 November to 15 March.

    The country has already witnessed the permanent closure of smaller non-compliant domestic mills. It is estimated that during FY2017–18, mills having yearly production capacity of 300 kilotonne (KT) were shut down due to the absence of environmental approvals.

    Moreover, China has limited and delayed annual import permits for domestic companies that receive wastepaper.

    These developments lead us to believe that, given the high cost curve globally and the ensuing rupee depreciation, the Indian paper industry should perform in the near term. Indian paper firms also have access to raw materials like wood and waste paper at competitive prices, while there is no supply glut fear. All of these combined should aid the earnings of industry players.

    Also read - How do price movements of raw materials impact a company’s profitability?

    The Indian paper industry is also expected to benefit from consolidation. In fact, consolidation has resulted in good tidings for residual firms, as seen in the telecom sector. There are around 20 paper companies that have stressed balance sheets and are understood to be operating at sub-optimal capacity.

    Indian paper trail

    It is important for investors to understand the dynamics of the Indian paper sector. It is a highly fragmented space where the top three producers account for a mere 9% of the market. In terms of installed capacity, Ballarpur Industries, ITC, TNPL, JK Paper, and West Coast Paper are the biggest. In terms of pulping capacity, Ballarpur is followed by TNPL, ITC, JK Paper, and West Coast Paper in that order.

    The domestic paper industry is dependent on imports of pulp, wastepaper, and pulpwood to meet their raw material requirements. This has compelled the firms to shell out extra money to secure raw materials, and such moves have impacted their profitability. Now, that situation could change.

    With China's curbs restricting waste paper imports, the possibility of an oversupply of waste paper is real. In other words, the overall cost for domestic paper firms could drop.

    Also read - Has China's central bank manipulated global trade?

    But let us not forget that higher imports of pulp from China can be counter-productive. If this trend plays out, pulp prices will remain firm, negatively affecting profitability. We have already seen how relief on the raw material side helps companies. For instance, during FY13–18, 15 firms saw their EBITDA and net profit margin rise by over 500 basis points (0.01% = 1 basis point). The increase in profit margins was mainly due to a decline in the cost of production. The scenario can repeat.

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