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G. Madhan

Paper Products: HoldEssel Propack: HoldCosmo Films: Hold

ONE of the more competitive segments, the going has been quite tough for the Indian companies in the flexible packaging industry. Even as Indian industry has generally been rejoicing over the recovery, the flexible packaging segment continues to face problems.

The tough operating environment was reflected in the movement of the share prices of companies, either in the mid- or the small-cap space. For instance, stocks of Paper Products and Essel Propack have been the laggards in the market. The value of a portfolio of eight of these stocks appreciated by 36 per cent in the past one year against a 67 per cent increase in the CNX Mid-Cap 200 Index.

Industry structure

The flexible packaging segment constitutes 20-25 per cent of the total packaging industry and is highly fragmented. Organised players account for 5 per cent. Flexible packaging can be broadly classified into two segments — basic material (polymer) makers and converters.

Polymer manufacturers make films — PET (polyethylene terephthalate), BOPP (biaxially-oriented polypropylene) or other polyethylene-based films. Companies such as Cosmo Films, which make BOPP films, and Jindal Polyester, which makes both PET and BOPP films, belong to this segment.

Converters make the end-product (flex-packs). Depending on the user requirements, converters process various raw materials such as films, inks and metal sheets into flex-packs such as laminates, labels, cartons, wrappers and tubes. Companies such as Paper Products and Orient Press fall under this segment.

Few vertically integrated players also form a part of the flexible packaging Industry. Essel Propack, for instance, has the capability that straddles the entire range, from film-making to tubing and capping.

Converters: Propelled by FMCG

Flex-packs, due to its convenience in handling and disposal, lower raw material cost and barrier against moisture and gases, find application in the packaging toothpastes, soaps, shampoos, detergents, processed foods, beverages and pan masala. To a lesser extent, it is also used in automobile and healthcare products. The revenue growth of converters depends on the fortunes of the fast moving consumer goods industry.

The frontline companies in the consumer goods industry have been having a difficult time over the past two years. Barring a few, most FMCG majors, including Hindustan Lever and Nestle, have seen sluggish or declining volume growth in select product segments.

Flex-pack converters have, however, not had such a major problem in achieving volume growth. In 2003, for instance, Essel Propack recorded 7.5 per cent increase in volumes over 2002. The volume growth of Paper Products was, however, higher at 22.5 per cent because it also focuses on smaller FMCGs that are growing at a faster pace. The revenue growth of these companies, however, was not commensurate with the volume expansion. The revenue of the former grew 0.3 per cent and the latter 19 per cent. The drop in revenue growth vis-à-vis volume growth could be attributed to the increasing pressure imposed by FMCG majors on pricing.

Polymer makers: Export-led growth

The revenue growth of polymer manufacturers has, however, remained fairly stable. Barring companies such as Cosmo Films, several polymer makers saw double-digit growth. MTZ Polyfilms, for instance, grew 18 per cent in 2003-04. The growth was higher at 31 per cent for Polyplex Corporation. The revenue growth of polymer makers, to a large extent, is driven by exports. Polyplex, which derives over 40 per cent of its revenue through exports, is a case in point.

Key inputs surge

For flexible packaging companies, the cost of raw materials is anywhere between 40 per cent and 70 per cent of the sales. The cost of raw materials, driven by the sharp increase in polymer granules prices, has seen a dramatic surge over the past one year.

For instance, the price of polypropylene, used to make BOPP films, rose 37 per cent in the last one year. The increase in the price of low-density polyethylene, the key input for polyethylene films, was 30 per cent. The price of polyester chips, the key input for PET films, also saw a firm trend.

The quantum jump in the cost of polymer granules has dampened the margins of several polymer film-makers. For instance, the operating profit margin (OPM) of Ester Industries fell 12 percentage points to 27 per cent. The OPM of the converters such as Paper Products also fell, as the cost of films showed a firm trend. The pressure on margins is likely to remain, given the firm trend in input prices.

Growth prospects

The price-cuts of personal-care products by FMCG companies appear to have had a favourable influence on their offtake. The volume growth of detergents, shampoos and toothpastes over the last few months has moved into the positive territory from the negative. This may aid the volume growth of converters in the coming quarters. This, however, may not necessarily result in higher revenues, as pricing pressures are bound to continue.

Besides, the converters have been traditionally price-takers and their ability to pass on the increase in cost to their customers, is limited. Hence, in the near term, one can only expect modest revenue growth for converters. Over the long-term, the profitability of converters will hinge on two factors: Their ability to broad base their revenue stream; and their ability to pass on the increase in cost to their customers.

For polymer makers, export markets will continue to remain the major source of revenue. Given the cost advantage and the robust overseas demand, the growth prospects for Indian polymer makers appear to be fairly bright. Greater stability in margins — similar to that of converters — will also hinge on their ability to pass on the increasing cost to their customers. The countervailing and anti-dumping duties imposed by the US on Indian polyester film-makers will, however, be a cause for concern.

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