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Paper Products: Margin pressure continues - Views on News from Equitymaster

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Paper Products: Margin pressure continues
Feb 7, 2008

Performance summary
  • Topline grows by 21% YoY and 14% YoY for 4QCY07 and CY07 respectively.
  • Though in 4QCY07, the margins improved by 0.5% YoY, for CY07, they were down 1.2% YoY.

  • Improvement in margins and lower tax outgo aided the net profit growth of 12% YoY for 4QCY07 excluding the extraordinary item.

Rs (m) 4QCY06 4QCY07 Change CY06 CY07 Change
Net Sales 1,272 1,533 20.5% 5,012 5,706 13.8%
Expenditure 1,146 1,373 19.8% 4,462 5,147 15.4%
Operating Profit (EBDIT) 126 160 27.0% 550 559 1.5%
Operating Profit Margin (%) 9.9% 10.4%   11.0% 9.8%  
Other Income 25 27 6.4% 98 108 10.0%
Interest 1 7 842.9% 3 17 476.7%
Depreciation 59 75 27.2% 231 289 25.2%
Profit before Tax 92 105 13.2% 414 360 -13.1%
Extraordinary item - 7 78 (22)
Tax 17 20 17.8% 93 54 -41.8%
Profit after Tax 75 92 21.3% 399 284 -28.9%
Net profit margin (%) 5.9% 6.0%   8.0% 5.0%  
No. of Shares (m) 62.5 62.5   62.5 62.5  
Diluted earnings per share* (x)         4.5  
P/E ratio (x)         12.1  
(*trailing 12 months)

What has driven performance in CY07?
  • The company reported a topline growth of 21% YoY and 14% YoY in 4QCY07 and CY07 respectively. With FMCG and food processing sector witnessing strong volume growth, PPL is benefiting from the same. Also, the shift of preference from rigid packaging to convenience packaging in FMCG along with booming modern retail is benefiting PPL on its volume front. Besides, the new plant at Rudrapur in Uttarakhand also helped the company ramp up sales during the year. However, the company lacks the bargaining power and due to the price sensitiveness of markets, performance would be expected to remain at current levels.

    Cost break-up
    As a % of net sales 4QCY06 4QCY07 CY06 CY07
    Total Cost of goods 71.6% 71.0% 69.7% 71.1%
    Staff Cost 7.1% 7.7% 7.5% 7.7%
    Other Expenditure 11.5% 10.8% 11.8% 11.4%

  • Though in 4QCY07, the margins improved 0.5% YoY, for CY07, they were down 1.2% YoY. The company’s raw materials are derived from downstream petrochemical products, which are in turn dependent on crude prices. With crude prices hovering at higher levels, raw material prices formed 71% of the sales in CY07. Further, the appreciation of Rupee vis a vis US$ also added to the margin pressure. The margins were below our expectations.

  • Improvement in margins and lower tax outgo aided the net profits growth of 12% YoY for 4QCY07 excluding the extraordinary item (account of settlement of claim). However, higher interest costs (up 843% YoY) due to lower base and expansion plans and higher depreciation reduced the growth to that extent. For CY07, excluding the extraordinary (excise duty – contingent liability) the profits were down 4.8% YoY. Lower margins, higher interest and depreciation led to the fall.

What to expect?
At the current price of Rs 55, the stock is trading at a price to earnings multiple of 6.0 times our CY10 estimates. The low bargaining power and higher raw material prices continue to pressurise the margins. PPL in order to command a higher price for its products and improve margins has come out with its initiative NASP (New Application, Structure and Products). This will aid volume growth along with market expansion. It will also help in offsetting margin loss of its other non-NASP products, where it has a weak pricing power, hence margins would be stable at current levels. The share of the new product is expected to touch 30% in the next two years.

Further, we believe, that the company is not easily dispensable, considering the importance of its packaging material for FMCG companies. Though the volumes are expected to grow, due to pricing pressure, revenues are slated to grow at a slower rate. With PPL's new capacity, we believe that the company will be in a position to grow its topline at a CAGR of 12% in the next three years.

The main kicker though is likely to come from improvement in operating margins, which is depended on the crude prices and success of NASP. We, in our estimates, have assumed the operating margins to touch 11% in CY10. We had given a ‘Sell’ report in April 2007, with a target price of Rs 66 from a CY08 perspective. The stock thereafter has corrected and at the current price, should give an 18% CAGR over the next three years.

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