BILT: Hold

Recommendation: Hold

S. Vaidya Nathan

THE earnings announcement of Ballarpur Industries (BILT) for the July-September 2001 quarter shows the strains of the downturn in the paper industry cycle. There has been stress both on the topline and bottomline.

Quite clearly, the two-year uptrend in the paper industry cycle seems to have come to a halt. The soft trend in pulp and paper prices were reflected in the international prices right from the start of 2001.

But in the Indian markets, the downtrend has begun to reflect with a lag, which is usually the case. Volume growth in the sector is around 3 per cent, in general, and 5 per cent at the best of times.

With input costs going up, paper companies are largely reliant on the price factor to boost profitability. After two good years, the party seems to have now ended, though in a few segments such as paperboards, the likes of ITC Bhadrachalam Paperboards have turned in impressive numbers.

The key numbers: BILT's topline growth rose 0.43 per cent with gross sales at Rs 384.63 crore in the corresponding period of 2000-01. By keeping a tight rein on operating costs, the company has managed to improve its level of operating profits by around 5.6 per cent.

The operating profit margin shows an improvement of 0.63 percentage point. If this trend of keeping a tight rein on costs continues, it may help shore up profit levels in a year when price increases are unlikely to come to the rescue.

A combination of higher interest costs and depreciation charges has led to an almost flat earnings curve. The rising trend in interest costs (7 per cent increase) at a time when interest rates are on a downtrend and sales levels almost flat, is a cause for worry.

The flat earnings curve is in contrast to the sharp growth rates reported in 2000-01. The post-tax earnings for the quarter is Rs 17.43 crore and the earnings per share Rs 2.18.

What is in store: In view of the slowdown in the global economy and consumer spending in key economies such as the US, the chances of a revival in pulp and paper prices in this fiscal (2001-02) appears remote.

Though new additions to capacities are marginal even at the global level, prices may not seek a higher ground in view of the sluggish demand. Producers have had difficulty in passing on price hikes and the proposed ones have had to be put on the backburner.

The domestic market trends may also reflect this global price-line though the depreciation in the value of the rupee has enhanced protection levels for the industry.

Given the global price trends, the ability to push through price hikes in the domestic market may be limited. As a player with a presence in all paper categories, BILT may see flat earnings for this fiscal.

Impending equity overhang: In this rather lackluster environment, there are two contrasting factors at work on the BILT stocks. First is the acquisition of Sinar Mas' unit from the Thapar group's privately-held companies. This would lift BILT's scale of operations at one stroke by 1.2 lakh tonnes.

This is a long-term positive. But in the next year or so, there could be some stress on the earnings of the merged entity. This is attributable to the fact that Sinar Mas' unit has a lower level of profitability. Last year, it made a profit of Rs 7 crore on sales of Rs 404 crore. BILT on the other hand had profits of Rs 100.28 crore on revenues of Rs 1,593.2 crore. The contrast is stark and once the merger is through, the overall picture may be one of pressures on earnings levels.

The other factor at work is the looming rights offer which would mean an expansion in the equity base. To bankroll the acquisition of BILT Graphics' entire equity, BILT plans to raise Rs 250 crore. BILT Graphics has the Sinar Mas unit under its fold now.

Given the current stock price levels of around Rs 36, this could mean a sizeable expansion in the equity base. At least a 50 per cent jump from the existing levels of Rs 71.55 crore may be on the cards.

With the expansion coming at a time when earnings growth may not match up, there would obviously be pressure on the per share earnings. But investors willing to wait for a year for the paper cycle to turn could stay invested.

There could be considerable scope for scaling up of revenues and earnings over the long term with the Sinar Mas unit and the planned expansion of capacity to 6.5 lakh tonnes over a three-to-four-year period.

Any sharp uptrend could be used to book profits. Fresh investments can be deferred till the rights offer is out of the way and the position could be evaluated afresh.