The Hindu Business Line : Paper and paperboards — A better script in the making

PAPER and paperboard stocks, especially the frontline ones of Tamil Nadu Newsprint, West Coast Paper and Seshasayee Paper, can be held and also considered for accumulation at lower levels, as the outlook for the industry in 2004 appears promising on the pricing front.

Earnings growth is likely to be driven largely by improvements in prices, as companies have pursued vigorous cost-control efforts over the past five years and there may be only limited room for further belt-tightening. On the raw material costs' front, the effect of the rupee appreciation may help lower costs of pulp imports.

In 2003 prices of pulp, which is the key raw material and whose prices provide a good indicator of likely trends in end-product prices, have shown greater resilience. They are likely to end the year with gains of 10-15 per cent.

International price trends are a key factor, as domestic prices reflect a similar direction especially with the substantial lowering of import tariffs. The appreciation in the value of the rupee by 7 per cent is also likely to strengthen the linkage as imports have become less expensive. However, the magnitude of the rise and fall is much smaller as compared to global trends.

A different price driver

Demand from Asian markets, especially China, has been the key factor over the past 12 months. This is in marked contrast to the firm trends in the past, which were driven by strong demand in the North American markets and to a lesser extent, Europe.

This year, these two key markets have been by characterised by sluggish demand.But the scorching pace of growth of the Chinese economy, a rebound in economies such as Korea and Taiwan, tenuous stability in Japan and a strengthening of other Asian markets have helped pep up demand levels.

For instance, newsprint shipments from the North American markets provide a clear view of the Asian story behind the gradual improvement in prices this year. In September, newsprint shipments were up by 35 per cent on a year-to-year comparison. This was also the 18th straight month of enhanced shipments to Asia. But for this peg to the pulp, paper and newsprint market, prices may have had a third straight year of weakness.

Better support cast likely

The steady improvement in the US economy augurs well. The 7.2 per cent GDP growth in the July-September quarter represents a significant break from sluggish trends over the past three years. Growth rates in the quarters ahead are likely to tend to lower, though well above the insipid numbers of 2001 and 2002. But this may translate into better demand for paper and paperboards, with a time lag though. This is clear from three vital statistics:

In a quarter that witnessed a sharp spurt in GDP, demand for most varieties of paper was lower by about 2 per cent in September 2003 on a year-to-year basis, and inventories have also declined only marginally, which points to limited scope for price increases over the next three months; however, the demand was higher on a sequential basis when compared to August;

The Conference Board Index Number that tracks advertising spends in print media continues to be at low levels, something not seen for a couple of decades; lower ad spends mean lower demand for newsprint, which has exerted pressure on prices; and

International Paper, the largest paper and forest products manufacturer in the world, has reported a decline of 23 per cent in earnings for the July-September quarter. The decline would have been more pronounced but for the strength in its forest products business that has offset widespread weakness in paper. But it expects improvement in the quarters ahead.

However, there is likely to be an improvement in 2004 if the economy continues to grow at 3-4 per cent. The base level of demand is much higher than in the Asian economies and even a modest pick-up is likely to have a significant influence on paper prices.

Domestic price trends

On the back of higher average prices, most paper majors have turned in better growth rates in revenues and earnings for the first two quarters of 2003-04. But they have had limited success in pushing through price hikes. However,on an average, the prices of most paper varieties have stayed higher compared to the preceding three years despite only a modest hike, so far, in FY 04. Prices in coated paperboards segment has stayed under pressure. If exports pick up and domestic growth rates in consumer goods show a sustained improvement on the back of bountiful rains, pricing may improve in this segment as well.

Check on costs pays

Efforts at cost control have also paid off and helped improve profitability. Paper companies have weathered a difficult two-and-a-half years with the following factors playing a key role: modernisation of pulp mills as well as other manufacturing facilities; improvement in energy consumption parameters; expansion of capacities; sizeable reduction in interest rate at the macro level and re-pricing of high-cost debt at finer rates.

By using the higher level of cash flows generated in 2000-01 to retire high-cost debt and finance expansion and modernisation through funds sourced at lower rates, companies such as West Coast Paper, Tamilnadu Newsprint and Seshasayee Paper have strengthened their position. Ballarpur Industries, too, has done likewise by dispensing non-core business and pursuing acquisitions.

Looking ahead

The process of consolidation that is now under way and discipline in capacity creation (see accompanying story) should stand the industry in good stead. Even if international prices do not hit the highs of 2000, leave alone 1994-95 when they were at twice the current levels, the earnings card over the next few quarters may sport a better look.

But if the gains are not to be just on paper, investors need to follow an active approach, as bullish phases in the paper industry have a history of swift twists and turns. However, for now exposures in most frontline paper stocks can be placed on a buy-and-hold mode.

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