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Company Background

Orient Paper and Industries Limited (Orient Paper), a part of C K Birla Group, is India’s largest manufacturer and exporter of tissue paper with ~17% domestic market share. Its integrated manufacturing facility is located at Amlai in Madhya Pradesh (MP) having a total installed paper capacity of 100,000 MTPA viz. 50,000 MTPA each of Tissue and Writing & Printing Paper (W&P). It also has 72,500 MTPA of pulp capacity and a 55 MW captive power plant. It also has 36,000 MTPA capacity of Caustic Soda, contributing ~15% to revenue. Vide a process of sequential demergers, its erstwhile cement and consumer durables businesses are now parts of two separate listed entities.

Investment Rationale

Better realisation resulted in topline growth of ~38.7% y-o-y

* During Q3FY22 Orient Paper’s net sales improved by ~38.7% y-o-y and ~17.7% q-o-q to Rs 1,641.9 mn, on the back of better realisation. Sales volume improved by ~1.9% y-o-y and remained flat q-o-q to 11,560 MT, while average realisation for the quarter improved by a whopping ~26.3% y-o-y and ~8.7% q-o-q to ~Rs 61,300/MT. W&P realisation improved by ~26.1% y-o-y and ~9.7% q-o-q to Rs 56,500/MT while, tissue realisation improved by ~26.1% yo-y and ~6.3% q-o-q to Rs 67,500/MT.

* W&P paper demand improved in October 2021 due to opening up of schools & offices and peak festive season demand. But due to fear factor of Omicron negativity, post-Diwali, the demand remains muted. However, with receding cases of Omicron due to successful implementation of vaccination drive in India and re-opening up of schools, outlook for W&P paper remains strong. The Government of India has not yet cleared its guidelines on New Syllabus. As a result, book publishing segment will continue to remain under pressure. Further, prolonged delay in arrival of imported paper due to on-going global logistics issues (unavailability of containers) and exponential rise in freight cost augurs well for the domestic paper manufacturers in general and Orient Paper in particular.

* On the other hand, Tissue paper demand remains robust in the domestic market, while softness in demand was witnessed in export market on account of logistic issues and high freight cost. Thus, management remains cautious on Tissue exports going forward.

* The worst seems to be over for the paper industry in general and for Orient Paper in particular and we expect demand to remain robust for both W&P and Tissue segment in the domestic market going forward. Orient Paper is well positioned for growth in coming years. We have built in a revenue growth of ~32%, ~25% and ~11% for FY22E, FY23E and FY24E respectively

EBITDA margins to stabilize at ~17.5% in FY24E led by better volumes and realisation

* During Q3FY22, EBITDA margin improved by 647 bps y-o-y and 889 bps q-o-q at 0.8%, while margin is still lower on account of higher costs, especially chemicals, energy and logistic costs. However, in order to mitigate cost inflation, the Company has taken several price hikes and a further price hike, going forward, cannot be ruled out.

* Going forward, we expect EBIDTA margins to stabilize in the vicinity ~17.5% on the back of better volumes and realisation in FY24E, led by better paper demand. Further, the Company is undertaking capex, which will result in lower fuel cost (higher availability of steam) and lower raw material cost (eliminate dependency on market pulp), the benefits of which will start accruing from FY23E onwards

Pulp capex will lead to raw material security and an additional tissue capacity

* To eliminate its dependency on market pulp (<10% of total pulp requirement), Orient Paper is increasing its pulp capacity from 72,500 MTPA to 100,000 MTPA at a cost of Rs 450 mn. It is also setting up a new recovery boiler at a cost of ~Rs 1.65 bn and upgrading its pulp capacity to become elemental chlorine free compliant at a cost of ~Rs 150 mn. The proposed capex will now be commissioned by Q1FY23E (from March 2021 earlier) and will be funded through a mix of debt and internal accruals. Post expansion, enhanced pulp capacity will support paper production of 120,000-125,000 MT

* To augment its enhanced pulp capacity of 100,000 MTPA, surplus power (>15 MW) and huge land bank in M.P, Orient Paper may take up brownfield tissue paper expansion of ~20,000 MTPA at its existing tissue capacity, expected to reach optimum utilization in a few years. This expansion can be done at minimal incremental cost and will take ~1.5 years for commissioning.

Balance sheet strength bodes well

As of September 2021, outstanding debt stands at mere ~Rs 1.5 bn, providing visibility to meet future capex requirements comfortably with marginal borrowings. Further, the Company holds investments worth ~Rs 6 bn in equity shares of Hyderabad Industries Ltd., (a Group company), Century Textiles and UltraTech Cement, in which the management intends to liquidate stake going forward. It also holds ~800 acres of land at its erstwhile plant at Brajrajnagar, closed since 1999, which, we believe, will be used for other purposes, going forward.

VALUATION

Indian paper industry was already impacted by a weakening macroeconomic environment and higher imports from neighbouring countries, which was further aggravated by COVID-19 pandemic. However, Indian Paper industry looks strong in the long term. With a rise in economic activity, receding threat of third wave of COVID and gradual opening up of educational institutions, earnings are expected to witness a strong recovery going forward. We have valued the stock on SOTP basis valuing Orient’s core paper business at 4.5x EV/EBITDA of FY24E and its investments (excluding Brajrajnagar land and Hyderabad Industries Ltd at 50% discount) at Rs 16/-share and recommend a Buy on the stock with a target price of Rs 42/- in 18 months (35% upside).

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