Paper: In a tear

S. Vaidya Nathan

THESE are not exactly the best of times for the paper and paperboard industry. This is in sharp contrast to the position the same time in the last two years. The industry cycle appears to have turned quite decisively, on the back of sluggish demand and resistance to price hikes.

International pulp and paper price trends have taken a turn for the worse since January 2001 (see accompanying story). The impact on domestic price trends has not been as pronounced as in the international market. But the stress is beginning to show.

Last week, India's largest paper manufacturer, Ballarpur Industries, reported marginal growth in sales and profits for the July-September quarter. The flat trends in its earnings clearly point to pricing pressures.

There are a few bright spots though in the Indian context such as coated paperboards segment where the volume and price trends have been more favourable. Ballarpur Industries reported a 62 per cent rise in profits in the July-September quarter. But this may be the exception rather than the rule.

Relying on higher prices

The paper industry depends heavily on price trends being firm. From the mid-1990s, this has been the key driver of profitability, ever since the import tariffs were lowered and left the industry more exposed to global price and demand-supply trends.

The industry does not have much leverage to improve profitability. Raw material intensity is high and where pulp is used, much of it is imported. The steady depreciation in the value of the rupee has not helped matters.

As for other costs, most of it, such as power and fuel, is of an administered nature. This means profitability improvement has to rely on prices and efficiency gains (where the scope may be limited due to the vintage nature of the manufacturing facilities). Here companies with more contemporary capacities, such as ITC Bhadrachalam and Tamil Nadu Newsprint (TNPL), have the edge. Most companies have managed to achieve a reduction in financial charges. For instance, in 2000, ITC Bhadrachalam Paperboard replaced close to 64 per cent of its debt by lower cost debt. TNPL also used cash flows from the good times of 1999 and 2000 to retire some debt obligations. Cash flows were also used to push through a capacity expansion programme.

Consolidation issues

Due to the fragmented nature of the paper industry, there are few major players, mainly Ballarpur Industries, ITC Bhadrachalam Paperboard, TNPL, West Coast Paper, Sirpur Industries, Orient Paper (which also has a presence in cement) and Seshasayee Paper.

Click here for Table

The situation of the paper industry is more or less similar to that of cement. The latter has, however, seen a significant consolidation, with the top six players controlling close to 62 per cent of capacities.

But this has not happened in the paper industry. The majors have preferred to add greenfield capacities rather than go the acquisitions way. This is because of the small capacities (of less than 50,000 tonnes) of the units that offer no major advantage.

All frontline companies have preferred modernisation and capacity expansion on their own steam. But this has been limited with the industry's profitability under stress for much of the last eight years. Consequently, just 30 per cent of the capacities are with the top players. There has been one significant consolidation that came about more by default than design. As its Indonesian parent slipped into bankruptcy, Sinar Mas' India stake was put on the block. BILT walked away with the capacity of close to 1.2 lakh tonnes.

This ramped up BILT's capacity almost 30 per cent and placed it in a position to lift these levels further. BILT now plans to raise capacities by a further 2.5 lakh tonnes to 6.5 lakh tonnes over the next three years. The acquisition also gives BILT a wider product range and it is set to consolidate its position at the top in terms of capacities.

Other consolidation activities are of intra-group nature. ITC Bhadrachalam Paperboards is to be merged with ITC, which already has a paper and boards business vested in the Tribeni Tissues division. The combined capacity in one company's fold could place ITC's paper business and BILT way ahead of the rest.

ITC may also have an edge over all others, including BILT, in growing the business on account of its strong cash flows which have limited use in its core business of cigarettes. Paper and hotels have been identified as areas of opportunity.

Investments of Rs 1,500 crore are planned for the paper industry over the next five years. In a major move, JK Corp is to vest its paper business with Central Pulp Mills. This is still in the pipeline and the specifics are yet to be announced. So, the top three companies are witnessing some churning of sorts.

Sluggish growth rates

The growth rate in the demand for paper has shown no signs of improving. The growth of the writing and printing paper segment has been capped at 3 per cent on an average. This segment is the bread-and-butter business for almost all players with the exception of ITC Bhadrachalam (its forte is in the coated paper boards segment).

The growth rates in the coated paperboard segment has improved at around 6 per cent. There is also the possibility of improvement in growth rate levels in this segment as more branded consumer goods take to better quality packaging. Even such segments as pharmaceuticals have seen extra layers of packaging added in a number of products.

Click here for Table

What may hold back volumes in this segment in fiscal 2001-02 is the slowdown in exports. From around 12 per cent last year, export growth is down below five per cent and there is no prospects of improvement appear dim. What may provide a cushion for ITC Bhadrachalam is its export thrust.

In the absence of any significant volume growth, the bottomlines of companies depend crucially on higher prices. This is unlikely to happen this fiscal if the global slowdown continues well into 2002.

Another aspect worth watching is the effect of a cut in production at the global level that helped stall the downtrend in September. But after the September 11 terrorist attacks on the US, the slowdown in most economies may get pronounced and neutralise the effect of production cuts.