India's Paper Industry to Grow at 6-8%/year,

but Faces High Input Costs

July 2013 - With a total consumption of 11.60 million

metric tons (MT), the Indian paper industry

accounted for less than 3% of global paper demand.

The per capita consumption of paper amounts to

around 10 kilogram (Kg), which is significantly lower

than world average of around 58 Kg and even the

consumption levels of some of the other developing

nations.

While the market size and per capita consumption

are relatively low, they have exhibited a rising trend

over past several years from 7.3 kg in 2008 to 10-11

kg in 2012. The total paper consumption has grown

at a CAGR of around 6% over last decade with none

of the last ten years showing a decline in

consumption demand.

The long-term demand outlook for the Indian paper industry remains favorable driven by

increasing literacy levels, growth in print media (particularly in the vernacular languages),

higher government spending on education sector, changing urban lifestyles, as well as

economic growth. Given that these factors are likely to be sustained, the paper industry is

likely to continue growing at a rate of 6-8% in the medium to long term although there

maybe aberrant years given the cyclical nature of the industry. In addition, the preparation

for general elections will provide further boost to paper demand in FY14.

SUPPLY

On the supply side, the industry saw significant capacity additions of 1.6 million MT during

FY09-FY11 (about 15% of domestic paper capacity in FY09) particularly in the printing-

writing paper (PWP) segment. The bunching of these capacities resulted in over-supply

scenario during FY11 and FY12 as these incremental capacities could not be absorbed in

Most of the paper mills that expanded

capacities have achieved operating rates

of over 80% in FY13.

the market. As a result, most players saw significant built-up of inventories as well as pricing

pressures in FY12. But with steady growth in demand, the market has now started

absorbing these incremental supplies and the inventory build-up that was noticed in Q2 and

Q3 FY12 is absent now.

Most of the paper mills that expanded capacities have achieved operating rates of over 80%

in FY13. Further, the industry has gone slow on new capacity announcements. As per CMIE

Capex, only five new projects have been announced in the last four quarters (Q1-Q4 FY13)

with an investment of Rs. 3 billion. However, some of the capacity expansions which were

announced earlier are already on track and are likely to be completed by FY14. ICRA

expects about 0.35 million MT of capacities to be added during FY14 and about 0.3 million

MT in FY15 (as against current capacity of about 13 million MT).

Even after assuming a conservative demand growth of 6% per annum, ICRA expects about

0.7 million MT of additional demand to be generated each year; hence the new capacities

will be absorbed in the market, although there may be temporary supply pressures in some

quarters.

PRICING

On the pricing front, PWP prices in coated segment have been affected due to cheap

imports from China. The imposition of anti-dumping duty by United States and Europe on

Chinese coated paper resulted in a diversion of cheap Chinese imports to India, thereby

creating a surplus situation in the domestic market. This put pressure on domestic paper

prices as the landed cost of Chinese imports was Rs. 4000-5000/MT lower than the

prevailing domestic prices in June 2012.

Although depreciation of Indian rupee has protected domestic manufacturers who

announced price hikes during Q4 and Q1 FY13, in Q2 FY13 the companies had to resort to

price cuts by Rs. 1500-2500/MT to remain competitive with Chinese imports.

Stiff competition from imported Chinese paper has continued to result in pricing pressures

on coated paper segment. Though domestic paper companies have tried to raise prices to

pass on the rising raw material and other costs, they have not been able to fully pass on the

rising costs to the customers.

In the uncoated PWP segment, prices have been hiked in the last one year to cover the

increase in input costs. Several leading paper manufacturers have undertaken a series of

hikes post November 2012 as the start of new session in schools pushed up the demand for

uncoated paper. Going forward, preparation for general elections will also support paper

demand to some extent.

In the newsprint segment, the domestic prices have remained stagnant Rs. 28000-

32000/MT in different markets over the last one year despite rising cost pressures. The

international newsprint prices (USA market) have also remained stagnant at around $610-

630/MT since Dec 2010 mainly due to muted demand in these markets. Though

international newsprint prices have remained stagnant in dollar terms, the depreciation of

Indian rupee has led to rise in prices in rupee terms. This has provided some pricing

advantage to domestic players to raise prices, although the superior product quality of

international newsprint and rising cost pressures faced by domestic manufacturers has

offset this benefit.

RAW MATERIALS - FIBER

Raw material availability continues to remain a key concern for the industry. The wood

availability for pulp making has been constrained on account of government regulations on

captive plantations by paper mills. The availability of wastepaper has been limited because

of low collection levels due to alternate uses of such paper in other applications such as

packaging.

The collection rate of wastepaper in India is limited to around 20% of the total paper

consumption in the country as compared to around 55-60% levels in developed countries.

Further the quality of wastepaper available from the domestic sources is generally of inferior

quality. As a result, the companies have to depend on imported wastepaper, exposing the

mills to movement in international wastepaper prices.

For the industry players based on agri-residues, the availability has been affected by cycles

in agricultural produce as well as alternate use of bagasse in power generation.

INPUT COSTS

Apart from issues regarding availability and quality of raw materials, the paper mills have

been affected by rising input costs. The prices of key raw materials such as wood and

chemicals have increased consistently over the years. Further, increase in domestic coal

prices, reduced availability of low cost linkage coal has increased the power and fuel costs

for paper companies. Though international coal and pulp prices have declined, this benefit

has been largely offset by depreciation of the Indian currency. The domestic coal prices

have consistently increased over the years. In May 2013, Coal India Limited revised the

price of low-grade coal by an average of 10%. Paper manufacturers have increased prices

over the last two years to pass on the costs, but the price hike has been insufficient to

absorb the costs.

GROWTH RATE

The paper industry reported robust growth in revenues during FY08-FY13 driven by steady

growth in consumption levels and increase in realizations. This period also saw steady

increase in the cost of inputs such as wood, chemicals, coal etc.

Over-supply scenario, rising cost pressures and increasing competitive pressures from

imports made it increasingly difficult for the paper mills to pass on these cost increases. As

a result, the operating profitability of the industry came under pressure in FY12. The

average operating margins of the companies in ICRA Sample* declined from 21.96% in

FY08 to 15.87% in FY13.

Though pricing flexibility has improved marginally with an improvement in demand-supply

dynamics, the profitability of paper mills continues to remain under pressure due to rising

costs of raw material, coal and chemicals. Further, high depreciation and interest costs on

account of debt funded capital expenditure undertaken by the industry have resulted in

pressure on net profitability of paper companies as reflected by decline in net profitability

from 11.34% in FY08 to 1.44% in FY13 for companies in ICRA sample. The funding of

capacity expansion projects through bank borrowings led to increase in gearing levels of

paper companies from the lows of FY06. High gearing levels (in the range of 2-3 times as

on March 31, 2012) coupled with decline in profitability has put pressure on the debt

coverage indicators of the industry.

OUTLOOK

Going forward, ICRA expects the paper industry to continue growing at the rate of 6-8% in

the medium to long term although there may be aberrant years given the cyclical nature of

the industry. The low per capita consumption of paper provides tremendous potential for

growth in paper demand.

Further the capacity addition program has now come to an end and there has been a

considerable slowdown in new project announcement and completion. With the recent

capacity additions coming to completion, any fresh announcements is unlikely in the near

term and with gestation period of about 24 to 30 months for new capacities, supply side

pressures have started easing.

Assuming a moderate growth of 6% per annum, the market would expand by approx. 0.7

million MT annually, which would be sufficient to absorb the new capacities that will come

up in the next 2-3 years.

However, the favorable demand-supply dynamics may not immediately translate into higher

profits for paper companies. The cost for most of the key inputs is currently at a very high

level and domestic coal and wood prices are still increasing at a rapid pace. The ability of

the companies to pass on these costs will remain the key to profitability. Companies with

better cost and capital structures and a diversified portfolio of products would be better

placed to endure the pressures in the medium term.

*ICRA Sample Includes Ballarpur Industries Limited, Seshasayee Paper and Boards Limited, Andhra

Pradesh Paper Mills Limited, JK Paper Limited, Tamil Nadu Newsprint and Papers Limited and The West

Coast Paper Mills Limited.

SOURCE: ICRA Limited (an Indian independent and professional investment information

and credit rating agency.)