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Paper Products: Margin pressure continues - Views on News from Equitymaster
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Paper Products: Margin pressure continues
Nov 16, 2007

Performance summary
  • Topline grows by 10% YoY and 11.6% YoY for 3QCY07 and 9mCY07 respectively.
  • Margins decline by 220 basis points (2.2%) in 3QCY07 due to higher raw material prices.

  • Profit after excluding the extraordinary item has grown by 159% YoY and 13% YoY for 3QCY07 and 9mCY07 respectively largely due to lower tax expenses.

Rs (m) 3QCY06 3QCY07 Change 9mCY06 9mCY07 Change
Net Sales 1,323 1,458 10.1% 3,740 4,173 11.6%
Expenditure 1,179 1,331 12.9% 3,316 3,775 13.8%
Operating Profit (EBDIT) 145 127 -12.4% 424 399 -6.0%
Operating Profit Margin (%) 10.9% 8.7%   11.3% 9.6%  
Other Income 16 20 24.1% 73 74 1.8%
Interest 1 5 242.9% 4 11 186.5%
Depreciation 57 75 30.0% 172 213 24.4%
Profit before Tax 102 68 -33.8% 322 249 -22.7%
Extraordinary item 135 10 -92.9% 135 (22) -116.6%
Tax 74 3 -96.5% 133 34 -74.2%
Profit after Tax 164 75 -54.3% 324 192 -40.7%
Net profit margin (%) 12.4% 5.1%   8.7% 4.6%  
No. of Shares (m) 62.5 62.5   62.5 62.5  
Diluted earnings per share* (x)         4.3  
P/E ratio (x)         11.4  
(*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 3QCY07?
Topline front: PPL is the largest organised player with a market share of around 40% of the estimated Rs 11 bn consumer packaging and labeling segment. The shift of preference from rigid packaging to convenience packaging in FMCG along with booming modern retail is benefiting PPL on its volume front. Further, the new plant at Rudrapur in Uttarakhand, which commenced commercial production in 1QCY07, helped the company ramp up in sales during the current quarter. Also, the projects of specialised pouching at Silvassa and specialized printing line at Hyderabad commenced production during the quarter, helping the company clock 10% YoY growth in the revenues for 3QCY07. As the food processing sector in India is still in the nascent stage and is witnessing strong growth, the capacity expansion would help the company meet the growing demand. However, though the 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. Low bargaining power as well as price sensitiveness of markets would continue to be the dampeners.

Cost break-up
As a % of net sales 3QCY06 3QCY07 9mCY06 9mCY07
Total Cost of goods 69.8% 71.8% 69.1% 71.2%
Staff Cost 7.8% 7.8% 7.7% 7.7%
Other Expenditure 11.4% 11.7% 11.9% 11.6%

Pressure continues: During 3QCY07, PPL’s operating margins declined by 220 basis points (2.2%) in the quarter. Higher operating expenses led to the fall in operating profits by 12% YoY. This was primarily due to higher raw material costs (as percentage of sales). Polymer based plastic films are the main raw materials used for manufacturing packaging films by the company. These plastic films are linked with the crude prices. With crude prices touching new highs in recent times, the company might continue to face margin pressure. Also due to competition in the market, it lacks the bargaining power both with suppliers and buyers. Despite strong presence in the premium segment, margins will remain subdued, notwithstanding NASP initiatives.

Extraordinary effect: Lower operating profits led the bottomline to decline by 54% YoY. However, excluding the extraordinary item, the bottomline has increased by 159% YoY in 3QCY07 largely due to lower tax expenses. Extraordinary item includes profit on sale of land and difference between the settlement and expenditure amount with respect to the damages to fixed assets during floods. However, at the PBT levels the company has witnessed a decline of 34% YoY. For 9mCY07, excluding the extraordinary items, the profits have grown by 13% YoY.

What to expect?
At the current price of Rs 47, the stock is trading at a price to earnings multiple of 5.7 times our CY09 estimates. The expansion in capacities would help the company meet the strong demand. The nature of the packaging industry is highly fragmented and competitive. Differentiation is the only mode of survival. PPL in order to command a higher price for its products and improve margins has come out with its innovation initiative NASP (New Application, Structure and Products). With flexible and convenience packaging replacing the traditional packaging, new product development is critical to sustain growth. However, the low bargaining power and higher raw material prices are likely to be the areas of concern going forward.

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