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Stock Recommendation | JK PAPER LIMITED – BUY – Target Price : 200
Publish date: DECEMBER 21, 2018
JK Paper (JK) will benefit strongly from a) surge in global pulp prices due to ban on imports of waste paper in China and low dependence of company on imported raw material compared to domestic peers, b) In-house pulp manufacturing and focus on farm forestry for raw material procurement likely to support margins, c) Acquisition of Sirpur unit and a brownfield capacity expansion in Gujarat will increase overall capacity by ~338KT/74% and d) imposition of anti-dumping duty on uncoated paper further supports profitability of domestic companies while investigation for coated papers is under process. Indian paper industry is expected to grow at a CAGR of 6.6% over the next 3-4 years. With the acquisition of Sirpur unit, we believe JK Paper will gain market share in the coming years and also help the company to supplement its product portfolio. Operating margins is expected to improve by 400 bps YoY in FY19E to 25.5% and likely to remain in the range of 24-25% in the near term. PAT is expected to register CAGR of ~16% during FY18-FY21E period. At CMP stock is trading at 6.9x/6.8x/6.9x FY19E/20E/21E earnings. We initiate coverage with a BUY rating and a target price of Rs.200.
■ Backward Integration and focus on farm forestry to support margin: We believe that JK Paper is in a sweet spot due to a) increased domestic sourcing of wood, b) weak domestic prices of wood and c) rising global pulp prices thereby increasing cost curve. JK Paper enjoys operating efficiencies because of its integrated production capacities, as a significant portion of wood pulp (pulp capacity of 276,000 TPA) and power requirements (80 MW) are met through captive production. Further, to reduce its dependency on third party for raw material sourcing, the company is running social forestry and farm forestry in Orissa, Gujarat, Maharashtra and Andhra Pradesh, covering a total area of 1,50,000 hectares, which helps them to source ~52% of total raw material consumption. Further reclassification of bamboo from forest produce to non-forest produce in Nov, 2017 shall increase the wood supply in the domestic market over the long run and will eventually benefit the local companies. Besides this, JK Paper is also focused on sourcing 71% of its raw material requirement from within a radius of 200 kms which results in reduced logistics cost. Given the captive procurement (52%) of raw materials and lower logistic costs, we expect operating margins to expand by 400bps in FY19E and likely to remain in the range of 24-25% in FY20E and FY21E (from 21.5% in FY18). The expansion in margins is also supported by increase in average realization in a rising global cost curve scenario. We expect realization to remain firm for FY20 and FY21.
■ Strong market position with presence in high quality brands: JK Paper is a leader in India's copier paper segment with a market share of 23%, the second-largest in the coated paper segment (market share of 12%) and a leading player in the packaging board segment, having market share of 11%. Its presence in copier paper, coated paper and flexible board are relatively less fragmented compared to paper industry. We believe, JK Paper’s position will further strengthen in terms of product offerings and help the company to gain market share with the operation of Sirpur unit (starting FY20E) and completion of brownfield expansion plan of 200,000 tonnes in Gujarat. Besides this, the strong marketing and distribution policies assure the company on faster product reach and better connect with the market.
■ Sirpur Acquisition to add ~30% capacity: JK Paper had shown interest in multiple assets, but due to disagreements on valuations, deal didn’t materialize. This shows, management’s conservative approach. Finally, JK Paper was successful in acquiring Sirpur Paper mill with an installed capacity of ~138KT (~30% of JK current capacity) by infusing Rs3.71 bn, post NCLT approval. This consists of a cash payment of Rs1.66 bn and issue of equity shares of Rs430 mn and preference shares of Rs1.62 bn. The management expects this plant to be fully operational in Q1FY20E. We believe, this acquisition will be EPS accretive to the company, supported by subsidies given by Telangana government, in terms of wood, coal and electricity duty.
■ Imposition of anti-dumping duty to boost profitability: The Government recently imposed anti-dumping duty (ADD) on certain kinds of uncoated paper from Indonesia, Thailand and Singapore for the period of three years to protect interest of domestic companies. The duty currently stands at difference between the landed value of the product and USD855/tonne. We expect, JK Paper to gain on the imposition of anti-dumping, as company’s uncoated printing and writing paper capacity stands at 292KT (third largest). ADD will be beneficial to the paper industry in a falling realization scenario.
JK Paper is a leader in India's copier paper segment, the second-largest in the coated paper segment and a leading player in the packaging board segment. We believe that, given the high cost curve globally and benefit of Sirpur paper mill to start accruing from 1QFY20E onwards, JK Paper growth rate is likely to be higher than the market and will also help the company to gain the market share. Besides this, the company’s focus on increasing farm forestry to fulfill its raw material requirements and capacity expansion at Gujarat, augurs well for the company. At CMP, the stock trades at 6.8x/6.9x FY20E/21E earnings. We initiate coverage on stock with BUY rating and a target price of Rs.200, valuing on SoTP basis. Valuing standalone operations at 8x FY20E earnings (25% discount to its 10 years average) and Rs18 from Sirpur operation.
Key Risks:
i) Significant capacity additions by domestic paper producers may result in increased supply in domestic markets (We believe, any fresh expansion either brownfield or greenfield would take 3-4 years to come on stream);
ii) Increase in crude prices, unavailability of water may lead to increase in cost of production;
iii) Slowdown in paper industry may result in underutilization of capacity
BUY - We expect the stock to deliver more than 12% returns over the next 12 months ACCUMULATE - We expect the stock to deliver 5% - 12% returns over the next 12 months REDUCE - We expect the stock to deliver 0% - 5% returns over the next 12 months SELL - We expect the stock to deliver negative returns over the next 12 months NR - Not Rated. Kotak Securities is not assigning any rating or price target to the stock. The report has been prepared for information purposes only. SUBSCRIBE - We advise investor to subscribe to the IPO. RS - Rating Suspended. Kotak Securities has suspended the investment rating and price target for this stock, either because there is not a Sufficient fundamental basis for determining, or there are legal, regulatory or policy constraints around publishing, an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon. NA - Not Available or Not Applicable. The information is not available for display or is not applicable NM - Not Meaningful. The information is not meaningful and is therefore excluded. NOTE - Our target prices are with a 12-month perspective. Returns stated in the rating scale are our internal benchmark. Kotak Securities Limited established in 1994, is a subsidiary of Kotak Mahindra Bank Limited. Kotak Securities is one of India's largest brokerage and distribution house.
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