ITC Bhadrachalam Paperboards: Hold/Buy on declines

Recommendation: Hold/Buy on declines

S. Vaidya Nathan

ITC Bhadrachalam has virtually come back from the brink. Better operating conditions in what was prima facie a good project, equity infusion, cleaning up of the balance-sheet and debt reduction have led to a turnaround of sorts.

Though the company has still not generated returns commensurate with investments, it is moving in that direction.

ITC BHADRACHALAM Paperboards is clearly on the comeback and shareholders can stay invested in the stock. Fresh exposures, in small lots, can be contemplated at declines from the current price level. This turnaround of sorts is reflected in its financial performance in the first quarter of 2000-01 and in the performance of the stock.

After losses in a few quarters, the company is back in black, even if only marginally. What is, perhaps, certain is that the worst may well be over unless the company takes up a big capacity expansion with highly-leveraged financing patterns.

Once a highly-fancied stock because of its performance and the ITC tag, it fell from the Rs. 500-plus levels in the mid-1990s to Rs. 15 in April 1999. The rally in economically-sensitive stocks led to a spurt in the stock price. While many stocks from this category retreated to the lower levels of the past, ITC Bhadrachalam Paperboards was among the few to hold most of the gains it made since April 1999 to date.

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Focus has helped

Spurred by the good cash flows of the 1990s and the prevailing trend then, ITC Bhadrachalam diversified into areas such as finance. None of its businesses in the unrelated areas proved to be a success. While the finance subsidiary found the going good initially, it quickly ran into trouble. This made a dent on the parent company's earnings and affected its cash flows.

There was also the controversy over import deals, which did not improve the company's image. But a cleaning-up act, with a massive cash infusion by the promoter company, ITC, has resulted in ITC's share in the company's equity going to 51 per cent.

Above all, the company's decision to focus on its coated paperboards and high-grade paper business proved to be an important factor in the reversal of fortunes. Fortunately, for ITC Bhadrachalam (unlike a number of others in the economically-sensitive sectors), it did not have much of a baggage to shed apart from the NBFC business. This also helped it get on track quickly -- something many other diversified companies have not been able to do.

Timing problems

The company's capacity expansion in the coated paperboards' segment to 1,82,000 tonnes per annum coincided with the downturn in the economy. The changed project contours and the delays in commissioning also did not help. The ITC Bhadrachalam's project also suffered with the Servall Engineering unit also going on-stream at around the same time.

This, with imports, created a supply overhang that brought pressure on profitability. The prices in the paper industry, in general, and in the paperboards segment, in particular, were on a downtrend. The slowdown in the economy, and of exports in particular, and the South-East Asian crisis compounded the situation.

What it effectively meant was that in the initial years of a big project, the industry environment was difficult. Company-specific woes and the high-cost borrowing added to the problems. For long a company with a fairly good profitability track record, ITC Bhadrachalam quickly slipped into the red.

But the one good thing that happened during this period was the growth in volumes. Sales (see accompanying table) rose modestly in an environment of falling product prices. The volume growth now comes in handy.

In the last one year, the enhanced exports and the opportunities also helped improve the capacity utiliasation levels. The opportunities in the export market also helped to neutralise, to some extent, the supply-side difficulties in the domestic market. The improved prospects of high-grade export quality paper also played a role in improving the company's financials.

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Restructuring the balance-sheet

The ongoing financial restructuring means that, operationally, things are on strong ground. The company is trying to retire high-cost debt (with coupon rates of 16-17 per cent), contracted in the mid-1990s when ITC Bhadrachalam was doubling the capacity of coated paperboards.

The company has cut close to 64 per cent of its high-cost debt exposures, replacing it with low-cost debt. The fact that a sizeable part of the latter has come from the market through issue of debentures points to improved perception of the company's position. The credit enhancement offered by ITC also appears to have helped contract fresh debt at finer rates.

The level of high-cost secured debt was reduced to Rs. 135.63 crores as of March 31, 2000 (Rs. 369.05 crores), while the unsecured debt rose more than five-fold to Rs. 292.28 crores as of March 31, 2000 (Rs. 54.42 crores). The change in the character of the debt contracted is another pointer to the improved perception of debt investors.

The restructuring of the debt portfolio should help improve the company's profitability this fiscal, apart from incremental contributions from the operations. The picture of the benefits may become clearer only by the end of the fiscal. But the relief on the cash flow front on account of lower financial charges may help the company bankroll capital expenditure without equity expanding.

Better future beckons

A combination of good volume growth, better price levels and lower debt cost should enable the company consolidate the profits seen over the past three quarters. As for the quantum of earnings, it is early days yet. However, if these trends persist, ITC Bhadrachalam may make respectable profits in 2000-2001.

The overall trends -- pulp and paper prices have shown a steady uptrend over the last 20 months -- indicate a better performance for the industry as a whole. This is longest period of price firmness since the highs of 1995. With the firm price trends driven by demand growth and consolidation at the global level among paper and pulp manufacturers, this may well continue for some more time yet.

ITC Bhadrachalam may also benefit from this trend, though the degree of improvement in paperboards may not be of the same order as in other segments. The improvement in exports too could lead to higher domestic demand. In 1998-99 -- the first full year of stabilised operations -- the company managed to record a 58 per cent volume growth and lift capacity utilisation beyond the 60 per cent mark. This fiscal may see much higher operating rates.

Business plans, outlined by the top management, also suggest that this trend may be sustained. What Mr. P. Dhobale, Managing Director, ITC Bhadrachalam Paperboards, outlined as the strategy is: The company is exploring ways and means to increase the sales volume of its premium products over the next two/three years. This would involve expanding the market among users of higher value-added products with advanced functional/graphic applications.

Investment outlook

Any sharp spurt in the short-term appears unlikely. But the ITC Bhadrachalam stock may be re-rated if the second quarter earnings announcement, due in October, confirms the turnaround achieved in the first half. But what is notable is that even after the recovery from the lows of around Rs. 15, the stock price is way off Rs. 100 at which the last rights offer was made. For shareholders who invested in the stock in the 1990s, it will be long haul before they get returns commensurate with the equity risks. They need to be patient in the wake of better performance by the company and wait for the re-rating of the stock.

But this stock carries a high degree of risk and the ability to cut exposures at the right time would be an important factor in making returns. For now though, it is not time to examine this angle. The current price levels and any declines could be used to build exposures from a long-term perspective.