India's Paper Industry to Grow at 6-8%/year, but Faces High Input Costs

Most of the paper mills that expanded capacities have achieved operating rates of over 80% in FY13.

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 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.

SOURCE: ICRA Limited (an Indian independent and professional investment information and credit rating agency.)