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Wednesday, July 30, 2008

Tamil Nadu Newsprint & Papers-Long Term Investment

High dividend yield, low valuations and a strong business model make Tamil Nadu Newsprint & Papers an attractive long-term investment bet

TAMIL NADU Newsprint and Papers (TNPL) is one of the leading manufacturers of printing and writing paper and newsprint in India. The paper sector is one of the most fragmented industries in the country. The price of wood pulp — which is the raw material for making paper — is rising sharply, squeezing the margins of companies. Environmental laws prevent forestation on degraded land. This prevents paper companies from attaining self-sufficiency in raw materials. Moreover, the production of bamboo — another raw material for manufacturing paper — has fallen sharply, thereby pushing up its prices. In addition, almost all large players are in expansion mode, adding and seeking new sources of raw materials.

The state government-promoted paper major, TNPL, was one of the first to initiate major capacity expansion in this industry. In the past three years, the company has spent nearly Rs 500 crore to increase its capacity. Going forward, TNPL plans to hike its capacity by another 70% to nearly 400,000 tonnes per annum by FY10.

BUSINESS:
The company’s business model is unique as it manufacturers paper from bagasse, which is the waste from production of sugar. It has an arrangement with sugar mills in Tamil Nadu for procurement of bagasse. This insulates TNPL from the fluctuations in prices of wood pulp.
For procurement of wood, the company has entered into a long-term agreement with Tamil Nadu Forest Plantation Corp. To meet its future raw material requirements, the company has set up a captive plantation. This backward integration has helped TNPL to become selfsufficient in raw materials, unlike many of its large competitors. The company also uses waste heat and baggase to produce enough power to meet its entire requirement.


TNPL has strategically changed its product mix over the past 7-8 years to match the market requirements. For instance, in FY01, newsprint constituted 33% of the company’s total production, while in FY07, newsprint accounted for only 1% of its total production.The demand for paper is increasing at a similar rate as the economy. As the level of industrialisation and education increases, the per capita consumption of paper is also set to increase in the country. The ongoing capacity expansion by domestic paper manufacturers is unlikely to hurt prices due to rising domestic consumption and exports. This bodes well for companies like TNPL.

FINANCIALS:
Financially, the company is one of the best-managed paper companies in the country. Its sales have been on a secular upside as TNPL has been able to change its product mix. The company’s sales and net profit have registered a compound annual growth rate (CAGR) of 13.6% and 20.1%, respectively, in the past four years. These growth rates are higher than that of other paper companies. The company’s EBITDA (earning before interest, depreciation, tax and amortisation) margin improved to 23.8% in FY08 from 16.7% in FY04, on the back of improved product mix and cost-containment measures.


TNPL has been successful in reducing the cost of its debt by swapping costlier debt with cheaper one. This is evident as its interest expense was more than Rs 50 crore in FY00, while it stood at less than Rs 25 crore in FY08. Moreover, the company has consistently paid dividends. In the past three years, TNPL’s dividend payout has witnessed a CAGR of 18%. Its current dividend yield is close to 5%. As profit growth is expected to remain strong in future, the company’s dividend payouts are also likely to follow suit.

VALUATIONS:
The stock is trading at a price-to-earnings (P/E) multiple of only 5.5, which is almost equal to the average P/E of domestic paper manufacturers. The company’s return on capital employed (RoCE) is in line with that of its peers. However, its consistency in sales growth, profit growth and RoCE is far better than that of its competitors. TNPL’s dividend yield is also the highest in the industry. All these factors make it an interesting long-term bet for investors.

MAKING THE WRITE CHOICE
Tamil Nadu Newsprint and Papers (TNPL) has spent nearly Rs 500 crore to increase its capacity in the past three years

It plans to hike its capacity by another 70% to nearly 400,000 tonnes per annum by FY10

The company’s business model is unique as it manufacturers paper from bagasse, which is the waste from production of sugar

Backward integration has helped TNPL to become self-sufficient in raw materials, unlike many of its large competitors

The company’s sales and net profit have registered a CAGR of 13.6% and 20.1%, respectively, in the past four years, which are higher than that of its peers

TNPL is one of the most widely held stocks in the paper industry

Institutional investors like Goldman Sachs and Templeton India Equity fund hold stake in the company

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