JK, West Coast Paper: Analysts bullish on paper stks despite 50% YTD surge

However, analysts say short-term investors should partially book out from paper stocks as the industry is a "classic cyclical play"

Despite the growing volatility in the markets, paper stocks have held their ground so far this calendar year. Shares of JK Paper, for instance, have surged 49.5 per cent on a year-to-date basis, while those of West Coast Paper, Tamil Nadu Newsprint & Papers, Ruchira Papers, and Andhra Papers have advanced between 26.3 per cent and 33 per cent, ACE Equity data show. In comparison, the Nifty50 and the Nifty500 indices have declined 2 per cent and 3.4 per cent YTD, respectively.

Analysts say tight paper supplies in the domestic market with reopening of economy, surge in paper exports due to shortage of paper in many countries, sharp increase in global pulp prices due to normalization of paper demand from China and growing global packaging demand due to shift from plastic to paper, and weak rupee (domestic paper prices are based on import parity prices and thus profitability is positively correlated to rupee depreciation), will support margin profile of key players.

"With the impact of pandemic receding schools, colleges, offices and courts have opened up full-fledged. With an uptick in demand, distributors have started stocking inventory. Also, inflationary trend has led to higher than normal demand at distributor level. Thus, the troika of demand normalization, higher level of demand at channels and favourable pricing has created a happy scenario for the likes of JK Paper, West Coast and Andhra Paper. Windfall gains can be expected for these companies over the next couple of quarters as per our channel checks," said Akhil Parekh and Kevin Shah of Centrum Broking in a recent sector report.

Owing to waste paper shortage, the raw material costs for Grade B/C paper mills have surpassed that of Grade A mills. Besides, pandemic led many offices, courts and schools to remain shut for a very long period of time. As a result collections remained very low. To add to misery, the European Union banned exports of waste paper in October, 2021.

Since Grade B/C mills make up for nearly 60-65 per cent of India's total production capacity with waste paper being the preferred raw material, pricing of recycled paper inched to Rs 60-65 per kilogram compared with Rs 50/kg in pre-pandemic times.

However, to remain on par/premium to recycled papers, Grade A mills, too, have taken price hikes with at least two hikes being taken in the last two months (6-7 per cent each). Analysts expect one more price hike (6-7 per cent) to come by the end of March or early April. Distributors, on their part, expect the situation to last at least till May-June this year.

Structurally, too, the capacity utilization of domestic paper mills is inching towards pre-pandemic levels. Analysts believe the sector will continue to operate at near full capacity for the next three years due to limited capex in the printing and writing (P&W) paper segment, and healthy demand growth rate seen in packaging board and tissue paper segment. Improving industry fundamentals, they say, is likely to result in improved pricing discipline for the sector in future.

Against this backdrop, analysts are bullish on JK Paper, West Coast Paper, and Andhra Paper due to attractive valuation. JK Paper is currently trading at 7.5x EV/EBITDA while West Coast Paper and Andhra Paper are trading at 3.9x and 4x of trailing EBITDA.

According to an analyst at a domestic brokerage, JK Paper and West Coast Paper Mills would continue to gain market share in future due to sharp improvement in financial risk on account of increase in the size of operations; weak financial risk profile of Ballarpur Industries (under corporate insolvency resolution process) and Tamil Nadu Newsprint and Papers (generated EBITDA of only Rs 91 crore in Q3FY22 as against net debt of more than Rs 3,000 crore); Century & Trident shifting focus towards non-paper business (real estate/textile); and small size of operation of other paper companies.  

Ajit Mishra, VP-Research at Religare Broking, too, suggests holding the stocks from a medium-term perspective as demand and pricing tailwinds support the outlook.

However, given the sharp up move in related stocks, G Chokkalingam, founder and chief investment officer at Equinomics Research says investors should partially book out from the stocks as the industry is a "classic cyclical play" and one should not stay invested for long-term.

Archana Gude, analyst tracking the sector at IDBI Capital, too, says the performance of paper companies on the bourses will remain robust until Q4FY22 as the companies will see margin expansion in March quarter. However, investors beyond a six-month perspective should book out.