TN Newsprint or JK Paper: The Final call - Views on News from Equitymaster

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TN Newsprint or JK Paper: The Final call

Jun 18, 2012

This is the third and final article evaluating which if any of TN Newsprint (TNPL) or JK Paper (JKP) one should invest in.

In our first article we discussed TNPL and JKP and their business models, innovation and other strategies, their product offering as well as their approach to raw material management.

We highlighted the fact that while TNPL's product offering is broad based, JKP is focused on value-added products. And we pointed out the critical different raw material inputs with TNPL using bagasse which can be managed more easily than wood which JKP uses. As a result, we indicated how the availability and pricing of wood poses a challenge to JKP.

We also observed that over the past five years TNPL had added production capacities whereas JKP had not.

We also pointed out that the Paper industry is highly capital intensive, and how it is imperative that companies in that space support their strategies and operations with strong balance sheets. So, in our second article we reviewed the financials of both companies.

From our analysis, we inferred that TNPL was outperformed by JKP slightly on all most key financial parameters. However, in terms of net profits, TNPL (13%) was significantly worse than JKP (25%). A key reason for this is that TNPL has relatively higher interest costs than JKP primarily because TNPL has, and continues to plan to add capacity where as JKP has not increased capacity.

In this article we study how both these companies fare in terms of a few other financial ratios, and finally current valuations.

Return ratios

TNPL has been adding more capital to fund its organic growth which is evident by identifying that the company's capital employed has grown by a CAGR of 24% during the last 5 years. However, with resulting higher interest costs, its net profit (profit before tax) grew by only 14%. So its Return on Capital Employed (RoCE) dropped from 14.8% in 2007 to 10.5% in 2011. On the other hand, JKP's capital requirements grew at a CAGR of only 3% over a 5 year period (due to no capacity additions), and so JKP was able to clock in a higher net profit before taxes CAGR of 22%. And for JKP, RoCE has moved higher from 10.9 in 2007 to 18.8 in 2011.

Further, during the past 5 years, TNPL's Return on equity (RoE) has increased marginally from 16% to 17%. In the same 5 year period, JKP's, RoE has moved from 13.3% to 20% over past 5 years.


Valuations

TNPL is currently trading at a standalone trailing twelve month (TTM) Price to Earnings ratio (PE) of 6.4 times, and JKP is trading at a TTM PE of 6.5 times. This implies that both the paper companies are currently trading at similar valuations.

Financials: TNPL Vs JKP over past 5 years
FactorTamil Nadu Newsprint LimitedJ K Paper
Strategy  
Growth strategyOrganic growth through capacity additionsFocus on value added products
Productsnewsprint, writing paper, paper for printing, industrial paper, value added paperdifferent types of value added paper
Raw material supplyProcures bagasse from sugar mills in exchange for steamHas a tie-up with farmers under farm forestry programme to procure wood
Revenues  
Net Revenues in 2011Rs 11.84 bnRs 12.30 bn
Revenue CAGR- 5 years8%10%
Revenue MixExports make up 20% of revenuesMore than 95% revenues from value added products
Last 5 yrs' Average Profit Margins  
Operating13%14%
Net Profit13%25%
Debt to Equity (last 5 years average)1.271.52
Valuations  
TTM PE (x)6.436.53

So which company do we invest in?

TNPL and JKP have very different business models and strategies. TNPL's growth is dependent on its broad product base, exports and adding capacity efficiently whereas JKP has a focused value-added products strategy that requires no product capacity addition.

And importantly, the two company's raw material inputs are fundamentally different (TNPL's being bagasse, and JKP's wood). Given all these considerations, we recognize that TNPL's net profits are not as good as JKP's, though the valuations of the two companies are similar.

However, we feel that in the long run, the winner will be the company that utilizes its raw material more efficiently. So far, TNPL has not derived much benefit from its advantage of using and managing the supply of bagasse, but going forward, the rising cost of wood may chop off some of JKP's profits.

TN Newsprint or JK Paper - Previous article


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1 Responses to "TN Newsprint or JK Paper: The Final call"

suresh

Oct 25, 2012

The most important consideration in this business is the availability of 'sustainable' raw material, and i think this is where TNPL scores over JK. There is a real risk associated with farm forestry going into the future, and is unsustainable. TNPL needs scale business given the product mix it has in it's portfolio, and that combination would be good bet for investments.

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