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Sunday, Jun 02, 2002

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Stay with these papers for now

S. Vaidya Nathan

Recommendations:
Ballarpur Industries: Hold/Avoid fresh exposures
TNPL: Hold/Buy on declines
West Coast Paper: Hold
JK Paper: Hold
Seshasayee Paper: Hold

STOCK prices of paper companies have moved narrowly in the past year or so. The only exception has been Tamil Nadu Newsprint, which spurted to around Rs 40 on the back of disinvestment speculation. But this is not likely to be a factor now.

Companies may be set for another year of disappointing earnings numbers in terms of growth. The year 2001-02 was not kind to paper companies and the story in 2002-03 may not be very different though the paper price cycle may be close to bottoming out.

But this may not be a good time for shareholders to cut exposures in the stocks. Not only is the broad market at lower levels, but profitability pressures are also weighing down paper stocks. It may be better to wait for the cycle to turn and then book profits in frontline paper stocks.

ITC Bhadrachalam no longer exists as a separate stock. The company has been merged with ITC, which turned in a modest show in 2001-02. The paper business is a small contributor to the earnings and cash flows. The coated paperboards segment where ITC Bhadrachalam is strong is also under intense pricing pressure.

But any view of the ITC stock has to be taken after considering its mainline tobacco business. What has happened as a consequence of the merger is that one of the few quality options in the paper and paperboard industry is no longer available. There are not too many options now.

Suitability

The stocks in the paper industry are inherently risk prone due to the higher degree of cyclicality and sudden changes in the price trends of end-products. A buy-and-hold approach may not help. But investors are better off taking exposures when the going is not good and booking profits when the paper price cycle heads upwards.

Ballarpur Industries (BILT): BILT is the largest paper manufacturer in the country, with its lead lengthening after the acquisition of Sinar Mas' paper unit. With a capacity of around 3.4 lakh tonnes to go with Sinar Mas' 1.2 lakh tonnes, BILT has a stranglehold on capacities among the organised players.

The company has a more focussed approach now after divesting its chemicals and other non-core businesses. The focus on paper could augur well for the valuation of the stock when the industry cycle takes a turn for the better. The company has come out with a rights offer at a price of Rs 38 per share and FCDs (fully convertible debentures) aggregating Rs 217.48 crore. The offer is to pay for the acquisition of BILT Graphic Papers from BILT Paper Holdings. As such the rights offer of equity and FCDs may lead to more than a doubling of the equity base.

At a time when profitability may be under strain, the equity expansion could have a dampening effect on the stock's valuation.

There is also an impending merger of BILT Graphic Paper and BILT. Against this backdrop, investors can stay invested and consider booking profits at a more opportune time. Fresh investments can be avoided till the effect of the rights issue and attendant equity expansion get priced in.

TNPL: The Tamil Nadu Newsprint stock seems to have moved out of the phase when disinvestment speculation was driving price trends. TNPL offers better exposure in the paper industry. The sharp decline in newsprint prices has had an adverse effect on performance. But the company appears to be combating the trend by switching some production to other paper varieties.

With a capacity of 1.8 lakh tonnes — slated to be expanded by a further 50,000 tonnes — the company has a reasonable scale of operations and contemporary capacity.

It has used the enhanced cash flows in 1999 and 2000 to cut debt and replace high-cost debt with lower cost debt.

For 2001-02, the company had sales of Rs 578.32 crore and profits of Rs 35.31 crore. The profits are down sharply from Rs 76.43 crore in 2000-01. But before deferred tax, which was not there last year, profit for 2001-02 was Rs 64.82 crore.

This shows a decline in performance linked to changes in the industry — the effect of the decline in paper prices and particularly of newsprint.

But from the long-term perspective, it may be better to place the stress on profits after deferred tax. Based on these earnings, the share now trades at a price earnings multiple of 7 times.

This may seem to be on the higher side for a paper industry stock. But this trend usually prevails when the going is bad.

Given the nature of its capacities, financial flexibility and the kind of ballooning of earnings in good times, it may be better to stay invested in the TNPL stock. Fresh exposures can be contemplated at around Rs 25.

Other paper stocks: Other paper companies that have a sizeable capacity are Sirpur Paper, West Coast Paper, Orient Paper and JK Paper (which emerged from the merger of JK Corp and Central Pulp Mills).

Though management concerns remain regarding the group's overall business profile, the JK Paper stock could merit watching as it is now one of the bigger players and has a presence in a range of product segments. West Coast Paper has scrapped a rights offer that had been in the offing for some time.

Investors in all these stocks should use any uptrend to pare exposures as the overall business risks seem to be high. These stocks have also not attracted much institutional interest, which is also true of BILT.

This could hamper the potential for gains on the upside. However, this may be the time to stay invested.

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