AP Paper deal

Paper stocks are in the limelight post the deal between AP Paper Mills and the US paper and packaging company International Paper. The deal is touted to be lucrative not only for the company but is being read by market analysts as a way to see consolidation in the paper industry. Amol Rao analyst with Antique Broking shares his detailed view on this recent deal in an excusive interview with CNBC-TV18’s Udayan Mukherjee and Mitali Mukherjee.

What was feared as a flash in the pan for the sector, Rao confirms that the deal is rerating the paper sector. “The pricing power is returning to suppliers, namely, manufacturers are seeing a recent round of CAPEX being absorbed easily, returns on capital employed and returns on net-worth are most likely to improve over the next two to three years,” Rao observes.

He believes with companies that have a robust operational set up, good distribution network, and a healthy balance sheet, under such a deal, “all International Paper has do is to take over the management and continue business as usual.”

Below is a verbatim transcript of Amol Rao’s interview. Also watch the accompanying video.

Q: Is the deal leading to rerating of the paper sector?

A: The paper sector is one where a lot of mispricing is happened on an asset basis. You have a huge gross blocks of Rs 3000 crore to Rs 4000 crore being valued at a market cap of around Rs 600 crore to Rs 800 crore. A company like BILT being valued at market cap of close to Rs 2000 crore is obnoxious.

However, the International Paper deal with AP Paper Mills has triggered off kind of a rerating in the sector. The pricing power is returning to suppliers, namely, manufacturers are seeing a recent round of CAPEX being absorbed easily, returns on capital employed and returns on networth are most likely to improve over the next two to three years. The paper sector looks like for a rerating and this deal has just proved it.

Q: What do we know about AP Paper in specific? What do you know about its own holdings and how that should be added on?

A: AP Paper on a capacity basis is a 2 lakh, 50 thousand ton paper company that recently commissioned capacity of around Rs 17,000. On an Enterprise Value (EV) basis, if you look at the transaction, it is been valued steeply at around Rs 94,000 or Rs 95,000 a ton, and what is surprising is the replacement cost is usually for a green field natural fibre based paper mill is around Rs 55,000. Hence, this makes the question about Rs 40,000 premium that has been paid for AP Paper.

Nevertheless, it makes sense for a company like International Paper to pay such a hefty premium for a simple reason that the business has no restoration period. The linkages are there for the wood; the business is up and running with distribution in place. Hence, all International Paper has do is to take over the management and continue business as usual. So this boards well for companies with a robust operational set up, a good distribution network, and a healthy balance sheet.

Q: Who are potential candidates in the paper space? Who do you think gets top rating by way of making these or being part of these consolidation moves?

A: The uniqueness about the paper industry in India is that there are no green field plants been put up in the country, land and water being major issues here. Therefore, everybody is fair game in this country right now and it would be speculative comment which companies are targeted for acquisitions. However, AP Paper was one of the top six in the country, so anybody in the top 10 is practically on the radar right now for any international company that wants to enter market and is most likely to double in 8 to 10 years.

Q: Do you think the excitement in paper sector is warranted?

A: I don’t think this would open the floodgate for deals or acquisitions or consolidation on a mass scale, but I would be inclined to believe that like cement, the valuations will wear towards this. The company valuations will over medium-term to long-term wear towards the AP Paper deal for sure. The reason for this is that it is practically impossible to set up a paper plant in the country, if you do not have one up and running. Hence, the lack permissions, space, resources would entail consolidation within Indian paper players or takeovers by foreign players.

There is no other way you can expand in India. The market is pretty exciting, which is why International Paper has come here. You do not have a market that is doubling its size in seven to eight years where probably almost 15% of the capacity has been absorbed; incremental capacity has been absorbed within six months of being commissioned. Hence, it really looks exciting but I would say this is more of short-term phenomena, over the long-term you will see valuations gradually wearing towards this deal.