Firm prices of writing and printing paper (WPP) and falling cost of production due to investments in efficiency improvement are bolstering the profitability of domestic WPP companies.
 

A CRISIL study of 71 WPP manufacturers – who account for nearly 50% of the segment sales volume – indicates improved cash flows will help reduce their aggregate net debt sharply, by around Rs 1,800 crore. Consequently, net debt will improve to ~2 times of EBITDA by fiscal 2019, from a peak of ~5 times in fiscal 2015.
 

In contrast to the subdued global demand growth for WPP -- at less than 1% – domestic consumption is buoyant at 5-6% year-on-year, driven by rising literacy, growing school enrolment rates and higher promotional spends. That, along with the closure of stressed domestic capacities, has led to supply constraints.
 

Consequently, paper prices have remained healthy at Rs 57,000 per metric tonne (MT), up 6-7% over the previous year. Moreover, with no major capacity addition, the supply from stressed capacities not expected to improve anytime soon and demand ruling steady, WPP prices are likely to sustain at healthy levels. Imports are unlikely to be a threat in this segment given higher freight intensity, low customisation and low serviceability.
 

At the same time, the cost structures have turned leaner for the WPP manufacturers on two fronts, viz. raw material and power, which form nearly 80% of the operating cost. Typically, a MT of WPP requires ~2.5 MT of wood, primarily sourced through farm forestry initiatives.
 

Manish Gupta, Director, CRISIL Ratings, says, “We are seeing acreage under farm forestry nearly doubling for most players over the past 5 years. With no notable increase in the prices of competing commodities since 2012, growing wood remains relatively more remunerative for farmers. Also, better yield per acre over the years, through use of cloned saplings, has helped farmers. The wood security, in turn, protects the industry against a 2012-type raw material shock.”
 

Also, higher captive usage of wood has ensured players are less affected by a rise in global pulp prices – while pulp prices increased 40% in past 5 years, raw material cost per MT was up just 15%-20%.
 

WPP players have also benefited from a 20-30% reduction in power cost per MT over the past five years. The reduction rode on the players’ focus on investing – almost Rs 500-600 crore in the past five years – in captive power generation, and their increased flexibility to use cheaper fuels. While lower coal and petcoke prices have helped, the plants – both new and refurbished – consume 8-10% less power per MT of paper produced.
 

As a result, the operating profit margin has improved 5 percentage points over past five years to 19% in fiscal 2017.
 

Subodh Rai, Senior Director, CRISIL Ratings, says, “We expect the industry to hold onto its healthy operating margins and generate an operating profit of ~Rs 11,000 per MT of paper produced per annum over the next two years, which is one-third higher than the previous five-year average. This improved cash generation is expected to lead to a decline in net debt levels by 25-30%”.
 

Though the credit outlook for WPP manufacturers is positive, they could diversify via acquisitions for faster scale or geographical diversification, or diversify into select industrial paper segments. Prudent funding thereof will be critical to CRISIL’s estimates and be a key monitorable.