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Orient Paper: Emerging stronger?...not by a mile - Outside View by Luke Verghese
 
 
Orient Paper: Emerging stronger?...not by a mile

The game changer

The dead 'founder patriarchs' of the Birla group are slowly being consigned to the dustbin of history by their own down the line succession chain. The companies founded and nurtured by Ghanshyam Das (GD) Birla were named as the AV Birla group by the former's great grandson, Kumar Mangalam (KM). And now his uncle - twice removed - has gone one better. Orient Paper and Industries founded in 1939 by GD's younger brother BM Birla is being referred to as the GP/CK group by the latter's grandson Chandrakant (CK).

The road is full of twists and undulations!

The chairman of the board, Chandrakant, in his message to the shareholders states that the road is never flat or straight; it is invariably full of twists and undulations. You can bet on that, from the manner in which Orient Paper is traversing the road ahead. The company should logically sooner than later be effecting a name change out of paper to cement and electrical, given the manner in which it is moving ahead on the production and sales front. It has of course completely lost steam along the way. It has also stopped moving forward out of pure inertia. In all possibility it started life as a single product, single plant, namely a paper unit in Orissa, located in Brajrajnagar. The letter B in the founder's name stood for Brij, and in all possibility Brajrajnagar was named after him. Today, ironically enough, this plant is completely mothballed and entombed like the founder himself.

Moving out of paper

Orient along with Ballarpur and JK Paper were amongst the market leaders in the paper manufacturing industry for decades. But it lost the plot at some point, and for reasons not clear today made a gradual shift to the manufacture of fans & light fittings, cement, industrial blowers, and such like. The company has two paper manufacturing units, one in Orissa, with a capacity of 76,000 tonnes, which is mothballed, and the other in Madhya Pradesh with a capacity of 110,000 tonnes, which switches on and off. The management is unable to find a solution to the water scarcity problem, of all things, in the latter plant. And even before it could it could find a permanent solution to the lack of availability of water, the management in its wisdom expanded the capacity of its paper tissue plant at this location by 15,000 tonnes to 110,000 tonnes per annum. But on an expanded capacity base, the paper unit produced 12,000 tonnes less paper in FY10 than in the preceding year. Now can this be referred to as a classic case of the left hand not knowing what the right hand is doing?

It is indeed unfortunate that this company, due to purely lethargy, seeks to refocus out of paper. Even more so as the directors' report states that the Right to Education initiative and the opening up of the higher education sector could unleash a huge demand growth for paper. The report goes on to add that the industry has in the past two years expanded paper capacity by 1 m tonnes and will add another 400,000 tonnes in the current year. In the process, Orient Paper gets reduced to being a two bit player in this expanding market. Why in heaven's name is the company educating us on the market fundas, when it has no intention of grabbing a piece of the unfolding action? And, in a year in which the proportion of value added paper increased from 9.6% to 15% in its total paper production, the company reported its first ever loss in this division. Sales fell to Rs 2.4 bn from Rs 2.9 bn, while it recorded a loss of Rs 431 m at the gross margin level. A screw is definitely loose somewhere.

The Kenyan mess up

And as if all this is not embarrassing enough, the company's joint sector project, Pan African Paper Mills, operating out of Kenya, has also sung its swan song. That would involve a write-off of around Rs 40 m, reflecting its equity stake in the project. The paper unit back home is bedeviled by weightier matters. Not only is there a lack of water supply, the state government has levied claims of Rs 1.5 bn as back taxes for water supplied. But these tithes have been contested by the company and not provided for. (Then there are other outstanding direct and indirect tax demands on various counts to the tune of a further Rs 500 m). This, then, is about as weird as it can get.

Cement to the fore

The two units that bring home the bacon today, is the cement unit, and the fans and the lighting unit. The various Birla factions have a fascination for cement. But here the company is a player of sorts. But it has yet to fully gear up capacity utilisation. On an installed capacity of 5 m tonnes it made do with a production of only 3 m tonnes, or a capacity utilisation of 60%. The situation is not much different in its other division. Capacity utilization of its electric fans unit was a little over 80%, while its lighting unit performed at only 46%. It also outsources and then sells the latter two product categories, as also the purchase/sale of exercise books. It purchased Rs 830 m worth of these products, and then flogged them for Rs 964 m, turning a small profit in the process. Based on segment results classification, paper accounted for 15% of all sales, cement 55%, and electrical durables another 30%. The total sales for the latest year included semi finished goods worth Rs 325 m.

Capital asset expansion of sorts

It is another matter than the gross block of the company has over the last two years vaulted 100% to Rs 16.4 bn from Rs 8.5 bn. (The gross block was fairly antiquated prior to this rejuvenation spree). This addition reflects the doubling of cement capacity to 5 m tonnes, the commissioning of a 50 MW captive unit, and the marginal addition to the paper manufacturing capacity. The capex also involved taking on an additional debt burden of Rs 3.5 bn, (as the company does generate sufficient cash from operations to fund such capital costs), with total debt at year end clocking in at Rs 5.1 bn. The management then has its work cut out for it in the current year, as increased depreciation and interest charges will weigh down on its cash flow.

Not the right funding mix

The reason for the funding gobbledygook lies in the innate conservatism of the management -which is also a Birla trait. But in this specific instance, this recourse is in reality a creation of more earth bound matters. The paid up equity remains at a miniscule Rs 203 m, but is backed up on paper with reserves of Rs 7.5 bn. Such a high level of reserves however, has little meaning, if the company's operations do not generate sufficient cash on a consistent basis. The bigger dilemma to a proper calibration of debt and equity funding, hinges on the holding of the promoter family in the equity sweepstakes. In this specific instance, the promoter holding in the voting power appears to be less than 34%. With such a precarious holding level, any mix of equity in the funding, requires a matching contribution from the family, to keep their stake in the post issue capital at par. This ability or the lack of it appears to be the big stumbling block on paper. Ever since the breakup of the larger Birla family, there are no tooth fairies who can be summoned via a magic wand to pitch in to help preserve the status quo.

So any expansion of capacity, or even the refurbishing of the antiquated plant and machinery, becomes a double edged sword. On the one hand, the capital infusion has to come via debt and therefore the capacity expansions have to be kept within arm's length, as the debt has to be serviced on both revenue and capital account. On the other hand, the additional issue of equity would lead to a further dilution of the parental hold on the company. This then is the singular issue bedeviling the company today. Other companies in the immediate family controlled set up apparently do not possess the fire power to chip in.

In all possibility, the cement unit will continue to be the real breadwinner in the future, assuming that the management does not lose focus in this division too. Unless the management is able to come up with some bright spark ideas, there is really very little to recommend in this share.

Disclosure: Please note that I am not a shareholder of this company

This column Cool Hand Luke is written by . 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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