It is ironical that an industry as vital as paper in the economic development of a nation should find such few friends in the stock market investing fraternity. The problem also is that the financials of this industry does not give out any positive vibes either
Making a go of it after half a century
This company is the twin sibling of Andhra Pradesh Paper Mills, originally promoted by the Bangur - Somani families decades ago. AP Paper was in the news not too many moons ago for engineering the lip smacking feat of selling the promoters' majority stake in the company to the American giant, International Paper for a perceived king's ransom. Needless to add the per share acquisition price more than raised market eyebrows. The flip side of this acquisition was that it led to an immediate re-rating of the other publicly listed paper companies - much to the undiluted glee of investors - which till the other day had no friends in the market. This deal in turn added to the razzmatazz of investing in stock market securities. Today AP Paper is chaired by LN Bangur, while West Coast Paper is chaired by SK Bangur. This company has been muddling around for some 56 years now.
The Industry statistics
The latest annual report of West Coast Paper Mills - which is an amalgam of both paper manufacturing at Dandeli in Uttar Karnataka, and telecom cable manufacturing at Mysore - has a medley of interesting statistics of the industry.
"The per capita consumption of paper in India is a mere 9 kg per year compared to 23 kgs even in Indonesia and 42 kgs in China. In the US it is as high as 300 kgs. The domestic demand for paper in 2010-11 was estimated at 10 million tonnes (MT) and it was met by 33 large paper units - with average production of 300 tonnes per day, and 623 units with average production ranging between 15-60 tonnes per day. In the last few years the industry has added nearly 1 MT of production capacity at a capital cost of Rs 80 bn. Additional expansion by 0.5 MT per year at a capital cost of Rs 40 bn is in the anvil.
'The capital cost of installed paper capacity for integrated pulp and paper is estimated at Rs 120,000 per tonne, which is considerably higher than the corresponding cost of Rs 40,000 per tonne for a steel plant. (This figure of Rs 120,000 per tonne is however completely at odds with the capital cost per tonne of Rs 80,000 based on statistics of Rs 40 bn for 0.5 MT, and Rs 80 bn for 1 MT, as mentioned earlier on! This therefore requires some clarification. Was the company referring to grass roots plants or to expansion schemes?) Producing a ton of paper requires 3.5 tons of wood, 1500 kWh of power, 1000 kgs of coal and around 100 cubic metres of water. The water consumption of Indian wood based paper mills and waste paper based mills, per metric tonne of paper produced, is infinitely higher than that of global paper units. Why this anomaly has not been addressed is not known.
'India's effective literacy rate touched 74% in 2011 catalyzing paper demand. With rising literacy rates the annual paper consumption is expected to increase to 20 MT by 2020.The Government has allocated Rs 520 bn for education in 2011-12, an increase of 24% over the preceding year. The allocation of Rs 210 bn for Sarva Siksha Abhiyaan (the government's programme that secures the right of children to free compulsory education) represented a 42% increase".
The company is a bit player
So where does West Coast Paper stand in the overall scheme of things in the domestic paper industry? The company manufactured 267,000 tonnes of paper in 2010-11.That would amount to 2.6% of the total industry production of 10 MT in this year. It is a bit player in the industry alright. In value terms the sales amounted to Rs 10.8 bn against Rs 6.1 bn previously, accounting for over 97% of gross sales (the paper sales included export sales of 13,650 MT amounting to Rs 531 m.) As stated earlier the company also makes optical fibre cables at its plant at Mysore. Rupee sales of optical fibres amounted to Rs 277 m against Rs 381 m previously. It also makes and sells a piddling amount of control cables. The cable business is merely hanging on to the coat tails of the parent and appears to be slowly asphyxiating. What synergy if any there is between the two product lines is unfathomable, but the company is clearly not uncomfortable banding the cable business under the same roof. The company also generates captive power and also sells a miniscule quantity of it.
Expansion does not necessarily change the economics
What is coming across quite clearly after a perusal of the latest accounts is that the manufacture and sale of paper, or atleast from the West Coast Paper point of view, is a zero sum activity, or something equivalent to it. Size does not matter it appears in the paper industry. The company has over the last four years or so increased the manufacturing capacity of its paper unit to 320,000 metric tonnes from 180,000 tonnes. And, the gross block has expanded from Rs 4.8 bn at end March 2007 to Rs 19.4 bn at end March 2011. This accretion to gross block must be largely related to the paper unit (excluding the expansion of its co-generation facility). And, from the balance sheet data it appears that overall the company's operations shifted into overdrive sometime in 2007.
The bigger issue here is that the gross turnover to gross block ratio also went for a toss from this year. In 2006-07 the company recorded a gross turnover of Rs 6.2 bn on a year- end gross block of Rs 4.8 bn. That is to say for every Re 1 gross block, the company achieved a gross turnover of Rs 1.3. Since then the position has reversed dramatically. In other words it got fewer bangs for the buck after the expansion scheme commenced. For, in the very next year the company recorded a gross turnover of Rs 6.5 bn on a gross block of Rs 8 bn. In 2010-11 the position was just as topsy turvy. On a year- end gross block of Rs 19.4 bn the company recorded sales of Rs 11.1 bn. That is to say on Re 1 gross block, the company recorded a turnover of only Re 0.6. Probably the situation may be reversed when the company achieves full rated capacity in production. In 2010-11 it produced 268,000 metric tonnes against 174,000 previously -against a rated capacity of 320,000 tonnes. The company also faces difficulty in generating internal cash to finance the gross block expansion. While the gross block expanded by Rs 14.5 bn over the last four years, the borrowings rose by 10.4 bn. This is without taking into account the expansion of its capital base from Rs 89 m to Rs 775 m - probably through the modicum of the issue of additional capital at a premium to the face value. (The company could have most definitely reduced its borrowings by more than a mite, if only it had fine tuned its net working capital management skills).
As I stated earlier size does not seem to make any difference in this business. Take a look at the statistics. In 2010-11 the net turnover rose a little over 70% to Rs 10.6 bn. More importantly, and measured by the efficacy of being in business, the company has little difficulty in unloading its product into the market place, as evidenced by the low trade debtor outstanding at year end. More importantly the production and sales of paper were also evenly matched. But, on the flip side, the cost of crucial variable inputs rose as much or even more, as compared to the increase in revenues. Raw material input cost rose 68%, and manufacturing expenses increased 80%. The company obtained a gross increase of 15.4% per metric tonne for paper sales. But the input cost of wood, and pulp, rose close to 11% and 21% respectively. These two items account for the vast bulk of raw material input costs. The cost increases in other major manufacturing inputs was just as vexatious. The consumption cost of stores and spares rose 81%, while the cost of coal and furnace oil hemorrhaged by 88%. (Input costs here are also going abegging inspite of the company generating its own power requirements.) Which brings us to the question of why the input costs of stores and spares would rise so dramatically for a revamped unit? One can be excused for having little control over the input cost of oil though.
Fab management of finances
Other expenditure items having a bearing on the bottom-line were just as unrelenting. Admin costs were higher by 39%, while interest costs debited to P&L account ballooned 361% to Rs 561 m. The fact of the matter is that the company is over geared relative to its ability to generate cash from operations. On paper the debt to equity ratio is very 'tanda' but accounting ratios have a way of masking the reality. The management may have faced difficulty in ponying up its share of equity - the management just about makes do with controlling interest of 51.9% - in the event of a further issue of capital and hence the recourse to debt. The interest element itself is a curtain raiser of sorts. The payout on interest account includes such bits and ends as bank charges and such like. Excluding such sums, the interest paid on its average debt of Rs 12.3 bn works out to 4.4%. This is truly a fantastic management of its finances and worth emulating, if only one knows how. Or has the bulk of the interest paid been capitalized and added to gross block? (In this context the company very wisely redeemed during the year its 12.5% coupon bearing debentures for a face value of Rs 650 m.)
Not surprisingly, depreciation charges have also rocketed by over 300% to Rs 961 m. The net result is that the profit before taxation rose only marginally to Rs 931 m from Rs 815 m previously. This is after allowing for a sharp increase in other income at Rs 125 m against Rs 63 m previously. Post tax profits jumped, but this is more due to the effect of accounting entries than any real cash inflow.
The company also has a deadwood investment in a fellow paper manufacturing unit sporting the name of Rama Newsprint and Papers Ltd. The direct equity stake of West Coast Papers in this unit is 36.3%, while the total group stake adds up to 49.1%. (Always keep the stake below 50.1% to avoid giving more information). The equity investment of Rs 454 m in this company appears to a dead loss, and not including the oxygen that it has advanced through the modicum of loans. It is not known whether there are any inter-se transactions between the parent and the younger sibling.
What the future fortells
Now that the teething problems have been overcome, the company may be able to produce at full rated capacity during the current year. This should enable it to rake up additional sales and create the cash flow that it so sorely requires to balance its books. The current years working will reveal how the company has gone about managing the task on hand.
Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme
This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.
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