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Paper Products: Margins woes continue - Views on News from Equitymaster

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Paper Products: Margins woes continue

Aug 8, 2007

Performance summary
  • With strong growth being witnessed in the FMCG sector and the shift of preference from rigid packaging to convenience packaging, the company’s topline grows by 12% YoY.

  • The EBITDA margins for 2QCY07 declines by 220 basis points to 9.4%. The raw material costs (as percentage of sales) increased from 68.9% in 2QCY06 to 71% in 2QCY07.

  • Without considering this extraordinary income, the bottomline falls by 12% YoY. This could be attributed lower operating margins and higher interest cost.

    Rs (m) 2QCY06 2QCY07 %Change 1HCY06 1HCY07 %Change
    Net Sales 1,256 1,413 12.5% 2,417 2,716 12.4%
    Expenditure 1,111 1,280 15.2% 2,137 2,444 14.3%
    Operating Profit (EBDIT) 145 133 -8.5% 279 272 -2.7%
    Operating Profit Margin (%) 11.5% 9.4%   11.6% 10.0%  
    Other Income 21 30 44.5% 57 54 -4.6%
    Interest 1 3 277.8% 2 6 156.5%
    Depreciation 56 72 28.5% 114 139 21.6%
    Profit before Tax 109 87 -19.8% 219 181 -17.6%
    Extraordinary item - (32)   - (32)  
    Tax 27 16 -43.2% 59 32 -46.7%
    Profit after Tax 81 40 -50.9% 160 117 -26.6%
    Net profit margin (%) 6.5% 2.8%   6.6% 4.3%  
    No. of Shares (m) 12.5 62.7   12.5 62.7  
    Diluted earnings per share* (x)         5.7  
    P/E ratio (x)         10.3  
    (*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, GlaxoSmithKline, 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 2QCY07?
    FMCG benefits: With strong growth witnessed in the FMCG sector and the shift of preference from rigid packaging to convenience packaging, the packaging sector is witnessing strong growth. Further modern retail is boosting the demand. Paper Products, being the largest organised player with a market share of around 40% of the estimated Rs 11 bn consumer packaging and labeling segment, witnessed a growth of 12% YoY for both 2QCY07 and 1HCY07. The Rudrapur plant is now fully operational and production is being ramped up. The company is also commissioning a specialised project, specialised labels and carton production line during the current year. Going forward, as the FMCG sector is able to corner a higher share of the consumer's wallet, we expect the company to benefit. Also, though volumes are expected to grow, due to pricing pressure, revenues are slated to grow at a slower rate of around 12 to 14% YoY over the same period.

    Margin woes continue: The company yet again reported a fall in the operating profits (down 9% YoY). The EBITDA margins in 2QCY07 shrunk by 220 basis points (2.2%) to 9.4%. The spike in raw materials cost by a huge 16% YoY has been the major culprit. The raw material prices (as percentage of sales) increased from 68.9% in 2QCY06 to 71% in 2QCY07. 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.

    Cost break-up
    As a % of net sales 2QCY06 2QCY07 1HCY06 1HCY07
    Total Cost of goods 68.9% 71.3% 68.7% 70.8%
    Staff Cost 7.9% 7.9% 7.6% 7.6%
    Other Expenditure 11.7% 11.5% 12.1% 11.5%

    Reflected in the bottomline: The company reported a 51% YoY decline in the bottomline for the quarter. However, this was on account of an exceptional item pertaining to the excise duty payments. Without considering this extraordinary item, the bottomline fell by 12% YoY. This could be attributed to lower operating margins, higher depreciation charges and interest costs. On the half yearly basis, the bottomline has fallen by 7% YoY (excluding the exceptional item). The net profits are below our estimates.

    What to expect?
    At the current price of Rs 59, the stock is trading at a price to earnings multiple of 10.3 times its trailing 12-month earnings. In order to meet the growing demand, the company’s plans to augment its capacity is a good move as the greenfield project accounts for around 25% of the company's capacity. However, with crude prices expected to remain firm going forward, the company might continue to face margin pressure. The company is also facing pressure on the wage cost front, as it will have to fork out higher salaries to prevent rising attrition rates. Also, it has a low bargaining power vis-ŕ-vis its key customers leading to high working capital needs.

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Mar 22, 2019 11:41 AM


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