This Ignored Sector Could Produce the Next Multibagger Stock

It was indeed a volatile trading session for Indian equity investors today. Indian benchmarks plunged tracking a sharp fall in global markets as global recession concerns heightened up.

The Nifty gave up the psychological mark of 17,000 as the Sensex plunged over 1,000 points.

The fall on broader markets was more severe. Midcap and smallcap indices plunged more than 4%!

Investors were back to hunting the best FMCG stocks and best pharma stocks as these stocks are often considered defensive.

Now, don't let this volatile phase scare you dear reader. This market correction may as well provide an opportunity to load up on undervalued stocks and beaten down sectors.

One such sector which was beaten down during the pandemic, and was overlooked by majority of investors, has invariably found its mojo back.

Impacted by the first and second waves of the Covid pandemic, India's paper sector is up for a revival.

The capital investment in this traditional sector has rebounded since the pandemic. Even mutual funds have turned bullish on market leaders and have increased exposure.

The paper sector was shunned by investors during the Covid-19 pandemic. Analysts were not willing to touch paper stocks with a ten-feel pole. Their prospects looked to be in danger with digitisation taking over.

But a lot has changed since the pandemic, and this beaten down sector is up for a strong rebound.

Why are paper stocks soaring?

The paper sector in India offers little reason to investors to be enthusiastic. Some of the biggest players have found it tough to remain resilient in this highly competitive and commoditised industry.

However, the performance of paper stocks in 2022 would say otherwise.

Performance of Top Paper Stocks in 2022

Company	31-Dec-21	23-Sep-22	Change (%)
JK Paper Ltd.	205.1	385.1	88%
West Coast Paper Mills Ltd.	235.1	522.7	122%
Seshasayee Paper and Boards Ltd.	149.6	282.0	89%
Andhra Paper Ltd.	218.0	441.8	103%
Tamil Nadu Newsprint & Papers Ltd.	122.2	241.1	97%
Satia Industries Ltd.	88.6	137.3	55%
Rushil Decor Ltd.	379.6	573.9	51%
Emami Paper Mills Ltd.	134.9	175.9	30%
Kuantum Papers Ltd.	79.2	117.2	48%

Data Source: Equitymaster

During the pandemic, the paper sector was severely affected as schools shut down and education was moved online. Newspaper publications came to a halt and a digital boom followed.

So basically, demand for paper was down in the dumps.

However, multiple factors came together at play which saw most paper stocks rallying in 2022.

Paper and companies manufacturing paper products were big gainers as India decided to reduce the use of plastics to reduce plastic pollution. The ban on plastic kicked in on 1 July. Paper stocks benefited from this as paper is an alternative to plastic.

Another reason behind the rally in paper stocks is most states are lifting lockdowns and announcing the re-opening of schools and offices. As kids move back from the PDF to paper for reading and writing, the prospects of paper stocks look good.

Paper companies gradually took unprecedented price hikes starting October last year.

Further adding to sentiment was the European Union (EU) lifting its ban on export of waste paper.

The EU lifted its ban on exports of waste paper from 1 April 2022, providing relief to the paper industry affected by the raw material shortage. This decision came at a time when the paper industry was reeling under pressure by the shortage of waste cuttings.

Now, a boring sector like paper has had its fair share of prolonged rough patches. But in the last one year, it invariably found the mojo back.

What next?

The important question is what lies ahead for paper stocks, and whether the rally will sustain?

Industry experts are of the view that paper stocks could do well in the near term owing to strong demand.

The industry body Indian Paper Manufacturers Association (IPMA) expects paper consumption in India to grow by 6-7% per annum in the next five years to reach 30 m tonne by financial year 2027. This would also make India the fastest growing paper market in the world.

The ban on plastic, educational institutions switching back to full-time physical classes and back to office for most corporates will make sure the demand does not get interrupted.

However, the sector is cyclical so exposed to volatility in raw material prices, as well as the threat of imports, which could prevent companies from passing on the increase in raw material prices.

Also, investors should understand the risk before investing in paper stocks as many are from smallcap or microcap segments. The daily average volumes are low in many of these stocks.

Which companies can be the biggest beneficiaries?

The backward integrated paper companies turned out to be the best paper stocks in India when the sectoral rally started. They will continue to have an advantage.

Having a backward integration, reduces dependency on third parties and paper companies can also control their input cost.

JK Paper, with its history of nearly six decades, has a competitive advantage. More so now after it completed capacity expansion this year.

JK Paper completed its virgin fibre based (VFB) packaging board and increased its capacity to 761,000 million tonne per annum (mtpa) Last year, the capacity stood at 591,000 mtpa.

Having its own backward integration has also resulted in JK Paper's cost per tonne to reduce 5% according to a report.

No wonder the company reported record numbers in financial year 2021-22.

JK Paper Financial Snapshot

Rs m, consolidated	FY18	FY19	FY20	FY21	FY22
Revenues	28,443	32,567	30,602	27,507	39,686
Growth (%)	8%	15%	-6%	-10%	44%
Operating Profit	6,437	9,181	9,752	6,743	11,348
OPM (%)	23%	28%	32%	25%	29%
Net Profit	2,606	4,273	4,753	2,400	5,426
NPM (%)	9%	13%	16%	9%	14%
Total debt	13,095	15,626	17,823	27,770	30,794
Debt to Equity (x)	0.8	0.77	0.75	1.1	1.03

Data Source: Ace Equity

Another company which has seen its cost per tonne fall is West Coast Mills.

The company has an integrated manufacturing set-up with in-house capacity to manufacture pulp and captive power plants. This helps the company recover a substantial portion of chemicals used in the manufacturing process and generate energy from waste.

Over 90% of the company's revenues come from the paper segment and its current capacity stands at 350,000 mtpa.

West Coast Paper Financial Snapshot

Rs m, consolidated	FY18	FY19	FY20	FY21	FY22
Revenues	17,102	19,791	24,929	22,445	33,777
Growth (%)	-3%	16%	26%	-10%	50%
Operating Profit	3,804	5,309	6,698	2,773	6,955
OPM (%)	22%	27%	27%	12%	21%
Net Profit	2,232	2,960	3,704	(31)	3,070
NPM (%)	13%	15%	15%	0%	9%
Total debt	3,215	3,674	7,585	6,680	4,517
Debt to Equity (x)	0.38	0.33	0.55	0.48	0.27

Data Source: Ace Equity

Recently, the company reported strong quarterly results owing to acquisition of Andhra Paper.

Another beneficiary in the space is Seshasayee Paper & Boards, a smaller debt free company compared to JK Paper and West Coast.

Interestingly, what makes Seshasayee Paper stand out is the synergies it brings.

The company has two manufacturing units. The one situated at Erode Tamil Nadu has excess capacity of pulp manufacturing, which is deployed at its second unit in Tirunelveli. The excess pulp production at the Erode unit caters to around two thirds of the pulp requirement of the Tirunelvelii plant.

Seshasayee Paper Financial Snapshot

Rs m, consolidated	FY18	FY19	FY20	FY21	FY22
Revenues	11,050	13,255	11,843	7,821	13,552
Growth (%)	0%	20%	-11%	-34%	73%
Operating Profit	2,162	3,187	2,893	1,260	1,812
OPM (%)	20%	24%	24%	16%	13%
Net Profit	1,233	1,921	1,816	1,064	1,100
NPM (%)	11%	14%	15%	14%	8%
Total debt	1,492	969	102	78	41
Debt to Equity (x)	0.21	0.11	0.01	0.01	0

Data Source: Ace Equity

And finally, don't forget ITC, which has a paper segment generating around 10% of its revenues.

ITC is among the top players in the specialty paper space and the market leader in the value added paperboards segment, or so its annual report says.

The company is in the process of developing an alternative to single use plastic. Its paper division has also been producing biodegradable and recycled boards that can be used by the food and beverage industry as a replacement for single use plastics.

Comparative Analysis of Top Paper Companies

Company	JK Paper	West Coast Paper	Seshasayee Paper	ITC	Astron Paper	Genus Paper
ROE (%)	19.7	22.5	8.5	25.9	4.5	5.4
ROCE (%)	16.6	23.1	11.7	33.8	1.5	5.7
Latest EPS (Rs)	41.4	69.7	23.9	13.2	0.5	1.1
TTM PE (x)	9.3	7.5	11.8	26.3	64.8	14.7
TTM Price to book (x)	2.0	1.82	1.35	6.5	0.9	0.8
Dividend yield (%)	1.4	1.2	0.9	3.3	0	0
Industry PE (x)	22.7
Industry PB (x)	1.8

Data Source: Ace Equity, Equitymaster

Final words

More tailwinds await the paper sector in the form of National Education Policy (NEP). The implementation of NEP in all states will also spur demand as the entire syllabus will be changed.

Think of the demand when new books get replaced with the old ones.

So overall, like electric vehicles stocks and semiconductor stocks, paper stocks too are in a sweet spot.

Stay tuned for more as we highlight such conventional sectors in the coming editorials.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such. Learn more about our recommendation services here...