The Indian Paper Industry, which was lagging behind in the markets, has gained a fresh lease of life after the acquisition of Andhra Pradesh Paper by International Paper. The deal has turned the tide for the industry with paper stocks getting re-rated on the bourses. But will this exuberance last? Finds out ET Intelligence Group?s Kiran Kabtta Somvanshi

THE Indian paper industry is on a roll. The acquisition of Andhra Pradesh Paper Mills by the world?s largest paper company, International Paper, has led to a churn in the industry with valuation getting re-rated and a renewed thrust on expansion.

The paper sector has been low profile with a few patrons on the bourses despite being considered as a core sector by the government. It has about 630 companies with an average production capacity of 39,000 tonne per player a year. It has been one of the most under-valued sectors in the stock markets with average industry priceto-earnings in single-digit. However, the acquisition of Andhra Pradesh Paper by the US company has turned the tide.

AP Paper was acquired at 16 times its prevailing EV/EBITDA ratio of 7, which experts consider as a very high valuation. The deal, however, has lifted the sentiment of the industry as a whole.

For instance, Ballarpur Industries, which was earlier planning to raise $330 million by listing on the London Stock Exchange, shelved plans hoping for better valuations. Another positive fall out of the deal was the initial public offerings of Servalakshmi Paper and Paramount Printpackaging, both of them having been over-subscribed. JK Paper, a leading player in premium paper category, plans to raise 225 crore through foreign currency convertible bonds.

So is the paper sector indeed promising or was the AP Paper deal just an aberration? The answer lies in tracking the growth of paper consumption in India and financials of paper companies.

While paper as a sector is facing slowdown in the developed parts of the world, such as North America and Europe, due to peaking consumption levels, it is steadily growing in developing countries like India and China. Per capita paper consumption in India was 9.6 kg against global average of 57.6 kg in 2010, industry data shows. It is much lower than most of its Asian peers. Consumption growth and production base in the world has been increasingly shifting to Asia.

The Indian paper industry is growing on the back of economic growth, thrust on educational initiatives and industrialisation. Demand for paper products such as tissue paper, tea bags, filter paper, copier paper and coated paper is growing in India. Different types of papers such as office paper, packaging board and copier paper are growing above 10% per annum.

Indian paper companies are better than their global peers in terms of return-on-equity, efficiency of operations, water consumption and low cost. Most of the leading players generate 20-22% return-on-equity. Growth in the sector will be led by increased consumption and rising capacities. Most paper makers in India are in an expansion mode funding it through borrowings or internal accruals. They are investing in upgrading their technologies to achieve more efficient and cost-effective scale of operations. The industry is capitalintensive registering steady growth. Paper prices have been rising and future outlook looks positive, as paper is one of the least volatile commodities. International Paper paid more than twice of AP Paper?s market price due to its strategically located plant, raw material linkages, established distribution network and low debt. As a natural corollary, only players with integrated and efficient operations and clear-cut strategic advantages would be the ones to enjoy increased valuations. The fragmented industry is also a fertile ground that could see some consolidation. With most players wanting to grow to meet the rising demand, merger and acquisition route may be used to expand inorganically. With 100% FDI permitted in the sector, more acquisitions by intern-ational players cannot be ruled out. In case where an entire sector is getting re-rated, investors need to be aware of the best companies to choose from. Leading players such as BILT, JK Paper, West Coast, TNPL, APPM and Rainbow Papers are safe bets. Following is the snapshot of these investment-worthy companies in the sector and what investors can expect from them in the near term.

BILT

BILT is the largest paper company in India. A part of the Avantha group, it is the only Indian firm to feature in the list of top 100 paper companies of the world. It is the market leader in coated paper segment in India. Its margins in paper business were hit by rising cost of pulp, power and fuel. The company has raised product prices to offset rise in input cost. It has a capex plan of 1,300 crore to increase pulp capacity and lower dependence on imports by fiscal 2012-13. However, high pulp prices will continue to weigh on the company?s margins in the near term. The company is planning to list its international subsidiary on the London Stock Exchange. The proceeds from listing will help fund its expansion and improve profitability. The paper industry is likely to consolidate in the near term and BILT, being the largest firm in the sector, will benefit. Long-term investors can look at accumulating the stock at lower levels.

APPM

Andhra Pradesh Paper Mills has sold a majority stake to the US paper major, International Paper, for about Rs 1,860 crore. The company could be worth investing in post acquisition due to the global expertise and brands that will come along with International Paper. Andhra Pradesh Paper?s current production capacity is 2.5 lakh tonne per annum (TPA). Its productivity and operating margins are seen improving over the next two years. Increase in efficiency in operations and expansion of product portfolio will boost earnings.

TNPL

Tamil Nadu Newsprint and Paper is the largest bagasse-based paper company in India. Bagasse is the fibrous matter that remains after sugarcane or sorghum stalks are crushed to extract their juice. It is used as a biofuel and as renewable resource in manufacture of pulp and paper products and building materials. The use of bagasse as a raw material makes Tamil Nadu Newsprint one of the most efficient and cost-effective in the local paper industry.

The company is promoted by the Tamil Nadu government. It manufactures newsprint, printing and writing paper. In fiscal 2010-11, the company undertook expansion of its paper production capacity to 4 lakh TPA from 2.45 lakh TPA, incurring a capex of Rs 1,000 crore. The company revamped its steam and power system, built de-inking pulp plant to produce pulp from waster paper and implemented a lime sludge management project at a capex of Rs 385 crore. The expansion will increase volume and improve operating profit margin.

RAINBOW PAPER

Ahmedabad-based Rainbow Papers is one of the fastest growing small paper companies. Commanding one of the best valuations on the bourses, the company is engaged in manufacturing different varieties of paper and after the current capacity expansion it will also produce valueadded products, such as glazed newsprint and speciality papers. It manufactures from waste paper, half of which is imported from overseas. Despite rise in waste paper prices, the company reported improvement in margins in the quarter ended March 2011.

In fiscal 2010-11, the promoters increased their stake in the company to 29.7% from 24.7%, reinforcing confidence in its business. In its phase I expansion, the company added 80,000 TPA capacity which led to enhanced performance in 2010-11. Phase II expansion is currently in progress, which includes building an integrated pulp and paper plant of 1.2 lakh TPA and a 20 MW captive power plant. Phase II expansion, which is likely to be complete by the end of this year, will boost earnings.

WEST COAST PAPER

Karnataka-based West Coast Paper is one of the most promising companies in the Indian paper sector. The company has been reporting robust performance since the past three quarters. It has a production capacity of 3.2 lakh TPA. The company is expanding its annual pulp-processing to 3 lakh TPA and paper-making capacity to 4 lakh TPA at a total investment of 1,400 crore.

The company?s capacity addition and robust realisations have improved its profitability. A small portion of its revenues is contributed by manufacture of optical fibre cable. The company has started pulp manufacturing to cut cost of buying it from outside. Its operating margin is one of the best in the industry. Increased demand for paper, firm paper prices, cost savings and improved realisations will boost the company?s earnings. It has management control in the country?s leading newsprint maker Rama Newsprint through a 53% stake that strengthens its presence in the growth-oriented sector.

JK PAPER

JK Paper is the largest producer of branded paper in India and a leading player in fine paper and packaging board segment. The company currently has a capacity of 2.7 lakh TPA. It plans to increase its capacity by nearly 50% to 4 lakhs TPA by the end of 2012 when its plant in Orissa will be operational.

The company plans to raise Rs 225 crore through foreign currency convertible bonds. It also plans to build a pulp mill in South Asia, which will enable it to source raw material at cheaper rates. Capacity expansion and good demand will boost earnings. JK Paper?s stock is under-valued with a trailing price-to-earnings multiple of 3.5. Its market valuation is a tad more than onefifth its annual net sales.

With the capacity expansion of most of these players rolling out over the next couple of years, the sector is a long-term play for investors.