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Paper Products: Tampered by margins

Feb 6, 2007

Performance summary
India’s leading manufacturer of primary consumer packaging and labelling materials, Paper Products Limited (PPL), announced decent results for the fourth quarter and the full year ended December 2006 (January to December fiscal). The topline rose by 10.6% YoY for the quarter driven by strong sales in the FMCG sector, PPL’s industry of dependence. Margins, however, fell due to higher raw material costs. The net profits declined by 10.6% YoY (excluding the extraordinary item) for the quarter. The Board of Directors has recommended a dividend of Rs. 9 per share (dividend yield of 2.1%).

Rs (m) 4QCY05 4QCY06 %Change CY05 CY06 %Change
Net Sales 1,151 1,272 10.6% 4,329 5,012 15.8%
Expenditure 1,004 1,146 14.2% 3,782 4,462 18.0%
Operating Profit (EBDIT) 147 126 -14.3% 547 550 0.6%
Operating Profit Margin (%) 12.8% 9.9%   12.6% 11.0%  
Other Income 33 25 -24.7% 95 112 17.6%
Interest 2 (1) -143.8% 5 3 -44.4%
Depreciation 62 59 -4.4% 249 231 -7.5%
Profit before Tax 117 93 -20.7% 387 428 10.7%
Extraordinary item 0 -   (8) 121  
Tax 32 17 -47.4% 102 150 46.4%
Profit after Tax 85 76 -11.0% 277 399 44.3%
Net profit margin (%) 7.4% 6.0%   6.4% 8.0%  
No. of Shares (m) 12.5 12.5   12.5 12.5  
Diluted earnings per share* (x)         32.0  
P/E ratio (x)         13.1  
(*trailing 12 months)

What is the company’s business?
Paper Products Limited (PPL) is India’s leading manufacturer of primary consumer packaging and labelling materials. The company has a history of over seven decades in the packaging field and its product folio includes flexible packaging, labelling technologies and specialised cartons. It has three fully integrated manufacturing units at Thane, Silvassa and Hyderabad. The company’s client list includes HLL, Nestle, Cadbury, Britannia, Glaxo SmithKline, Coca Cola, Perfetti, Dabur, Marico and P&G. Exports constitute around 14% of total revenues and the company’s international division services large multinationals like Nestle, Unilever, Cadbury and Colgate Palmolive across four continents. In 1999, PPL became a subsidiary of Huhtamaki, a global leader in consumer packaging, which holds a 59% stake in the company. Huhtamaki is headquartered in Finland and is one of the top 10 consumer packaging companies in the world.

What has driven performance in CY06?
Capitalising on FMCG: PPL continued to capitalise on the burgeoning FMCG sector growth in the country, with the topline growing by 15.8% YoY for the year. Volume gains were a result of changing lifestyles as well as the modern retail formats. With the FMCG sector witnessing strong growth both from rural and urban areas, shifts to more hygienic and convenient packages and increasing distribution networks, the volume growth is expected to continue going forward. Being the largest organised player with a market share of around 40% (volume terms) of the estimated Rs 11 bn consumer packaging and labeling segment, PPL is well positioned to benefit from these developments. NASP, the company’s innovation initiative has helped it to grow its business, acquire new customers and spread geographically. The company in order to meet the growing demand is expanding its manufacturing capacity by setting up an additional facility at Rudrapur in Uttranchal at an expected cost of Rs 650 m, which would be funded by internal accruals. The expansion is expected to be fully completed by June 2007. The Phase 1 of the expansion plan has gone on stream in January 2007. This will help the company increase its production and ride on the FMCG growth story.

Cost break-up
As a % of net sales 4QCY05 4QCY06 CY05 CY06
Total Cost of goods 67.8% 71.6% 68.7% 69.9%
Staff Cost 7.6% 7.1% 7.4% 7.5%
Other Expenditure 12.4% 11.5% 11.2% 11.8%

Material costs pressurise margins: During CY06, PPL’s operating margins witnessed a 160 basis points decline. In fact, operating profits on an absolute basis were up by a mere 1% YoY. This was primarily due to higher raw material costs (as percentage of sales). The company’s raw materials are derived from downstream petrochemical products, which are in turn dependent on crude prices. With the crude prices being volatile going forward, the company might continue to face margin pressure. PPL also lacks bargaining power both with suppliers and buyers. Besides, it operates in a very competitive market marked by price competition. Despite strong presence in the premium segment, margins will remain subdued, notwithstanding NASP initiatives.

Extraordinary effect: The company reported a 44% YoY growth in bottomline for the year. However, this was on account of an extraordinary income received in CY06 pertaining to the sale of land and the settlement claim amount on account of the July floods. Without considering this extra-ordinary income, the bottomline has declined by 2% YoY, which could be attributed lower operating margins. Also, there was a provision of tax on receipt of Rs 121 m on account of insurance claim arisen from damages on account of floods in the Thane plant, which further impacted the bottomline.

What to expect?
At the current price of Rs 419, the stock is trading at a price to earnings multiple of 13.1 times its trailing 12-month earnings and 18.8 times earnings if one were to exclude the extraordinary income. With strong demand being witnessed in the FMCG sector and consumerism reaching new highs aided by modern retailing, Paper Products is expected to benefit from the same. Also, with its new capacity coming in, the company will benefit in terms of stronger volume growth. Though the pressure on raw material costs might lead to near term hiccups, NASP would help PPL command a higher price for its products resulting in margins being relatively higher in the long-term. This is likely to help the company offset the margin loss of its other non-NASP products.

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