Outlook 2011: Indian Paper Industry to Grow

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www.asiapapermarkets.com February 2011 BRIEFING PAPER

Fitch Ratings Outlook Report: Indian paper industry to grow but profitability likely to be hit by rising input costs Rising fuel and chemical cost may impact the profitability of writing and printing paper producers. Raw material shortfall & cheap imports some of the challenges facing the industry.

itch Ratings has said that the ratings of Indian paper manufacturers would remain stable in 2011 on the back of growth in domestic demand owing to favorable economic environment. The average sales prices for paper manufacturers are likely to be higher in 2011, but rising input costs would prevent improvement in their profitability. This coupled with higher amount of debt owing to the capex plans could stretch the credit metrics of some paper manufacturers in 2011 compared to last years.

Industry executives confirm the projected scenario. Rising fuel and chemical cost may impact
the profitability of writing and printing paper producers such as BILT, JK Paper, West Coast and TNPL, in the second half of the current financial year, a Business Standard (India) news report (dated January 13, 2011) quoted industry members as saying. The cost of pulp, however, has not moved up. Production cost will be higher in the second half of the current financial year since cost of inputs such as fuel and chemical has been rising, A Velliangiri, deputy managing director, Tamil Nadu Newsprint and Papers Ltd. (TNPL), informed Business Standard. Sustenance of economic growth momentum would manifest itself in a favorable domestic demand scenario for paper sector during 2011, says Pragya Bansal, Associate Director in Fitchs corporate team in India.

The Indian paper industry has close linkages with economic growth as higher industrial output
leads to increased demand for industrial paper for packaging, increased marketing spend benefits the newsprint and value-added segments, and increased education and office activities increase demand for writing and printing paper. Fitch forecasts economic growth of 8.5% for India during financial year ending March 2012 (FY12), which will benefit the demand for paper.

The 5.6% cumulative annual growth rate in paper consumption (excluding newsprint segment)
over the last five years has prompted Indian paper manufacturers to undertake significant capacity expansions. Capex requirements for some companies are large in relation to their internal cash flows, which may necessitate significant borrowings, especially as Indian paper manufacturers have not been active in equity raising, says Abhinav Goel, Senior Director in Fitchs corporate team in India.

The cost of input material, primarily pulp, has increased during last one year after remaining
subdued during 2009. This trend of high input prices may persist in 2011 owing to growing demand in emerging economies. Since India imports a significant part of its pulp requirements for value-added paper, the Indian paper manufacturers shall be exposed to volatility in global pulp prices in 2011.

However, opinion is divided as to what extent pulp costs could impact profitability in 2011. As
of now, as per Indian industry reports, the cost of pulp has remained steady in the range of $650-700 per tonne. Pulp prices were expected to go down to around $500 per tonne, but has remained steady, said V Kumaraswamy, chief financial officer of JK Paper, adding the impact on profit would not be a drastic one. BILT, the biggest domestic paper manufacturer, however, said the profit margin would improve since pulp prices were lower. We do not see pulp prices hardening from here, said B Hariharan, director (Finance). India imports about two million tonnes of pulp (soft wood and hardwood) and waste paper (sack waste for unbleached grades, envelopes waste, cup stock for white grades and magazine waste) for newsprint.

The paper industry did well in the April-June period last year. It was able to improve its
realization, while cost had been stable. Most companies were able to increase prices by over 8 per cent. TNPL, for instance, saw a net profit of Rs 93 crore in the period, up 152 per cent from corresponding period in the previous year. Seshasayee Paper saw its net profit move up over 87 per cent to Rs 39.84 crore. JK Paper saw its net profit move up over 33 per cent to Rs 58.19 crore.

Growth in paper demand coupled with scaling down of capacities in developed markets could
pose a challenge with respect to availability of pulp in the short to medium-term. To counter this, large Indian paper manufacturers are undertaking backward integration through social farm forestry, and setting up captive pulping facilities to secure pulp supplies for their manufacturing facilities. Moreover, domestic paper manufacturers are increasingly adopting flexible pulping facilities, which can use multiple input materials such as agri-residue, waste paper and wood.

Increased capacity is expected to result in slightly reduced capacity utilisation over the short- to
medium-term. Moreover, the new capacity additions would increase the competition among domestic paper manufacturers and prevent increase in paper prices in the medium-term. As a result, the Fitch Ratings expects the credit metrics of Indian paper manufacturers could deteriorate owing to the large debt-funded capex, and margin pressures. (Source: Fitch Ratings)

As per Indian industry reports, the industry is faced with a capacity overhang of nearly one
million tonnes in the past two years. Companies like BILT, TNPL, West Coast Paper and Andhra Pradesh Paper have added capacities most of which became operational in the last calendar year. Lot of capacity addition has been done, both in the organized and unorganized sector. There is an overhang of extra supply that will get absorbed in the next year, said RR Vederah, managing director, BILT, informed Business Standard.

Indian Paper Manufacturers Association projects that Indias demand for paper is expected to
double to 20 million tonnes by 2020 but a perennial raw material shortage remains one of the major hurdles before the industry. The paper demand is expected to cross the 20 million tons mark by 2020. The major constraint in capacity enhancement that the industry faces is related to raw material shortfall, IPMA President ML Pachisia said. IPMA represents sixteen major paper manufacturers of the country. As per IPMA, the present paper manufacturing capacity across the country stands at around 10 million tonnes, which is similar to the demand.

Another challenge facing Indian paper producers are cheap imports from China and Indonesia.
There is a perception that with U.S. imposing high anti-dumping duty on several varieties of Chinese paper being imported to the U.S., Chinese producers may be looking at India more seriously as an alternative market. A threat is there, said M L Pachisia, managing director, Orient Paper and Industries.

Chinese imports had forced some companies to take a price cut of up to Rs 3,000 per tonne on
coated paper. While they have tried to increase the price by Rs 1,000 from January, there is some resistance from the market. Chinese coated paper is available at around Rs 49,000 per tonne, which is Rs 2,000-3,000 lower compared to domestic price. The industry, therefore, is lobbying the government for stricter protective measures and the imposition of anti dumping duties. We want a level playing field when it comes to cheap imports from China and Indonesia, Mr. Pachisia added.

According to the Associated Chambers of Commerce and Industry of India (ASSOCHAM),

Indian paper industry is poised to grow and touch 11.5 million tonnes from 9.18 million tonnes to 2011-12 from 2009-10 at the rate of 8% per annum. The ASSOCHAM paper on Growth of Paper Industry in India, indicates that per capita paper consumption increased to 9.18 kg on 2009-10 as compared to 8.3 kg during 2008-09. Still, the figure is low (9.2 kg) compared to 42 kg in China and 350 kg in developed countries. ______________________________________****____________________________________

The Indian Paper Industry: Some Facts The Industry:

India has emerged as the fastest growing market when it comes to consumption, posting 10.6%
growth in per capita consumption of paper in 2009-10.

India produces many varieties of papers, namely, printing and writing paper, packaging paper,
coated paper and some speciality paper. Varieties under printing and writing paper are creame wove paper, super printing paper, maplitho paper (non-surface and surface size), copier paper, bond paper and coating base paper and others. The varieties under packaging paper are kraft paper, boards, poster paper and others. The other varieties under coated paper are art paper/board, chromo paper/board and others. There are approximately 600 paper mills in India, of which twelve are major players.

Paper in India is made from 40 per cent of hardwood and bamboo fibre, 30 per cent from agro
waste and 30 per cent from recycled fibre. Newsprint and publication paper account for 2 million tonnes, of which 1.2 million tonnes of newsprint paper is manufactured in India and the remaining 0.8 million tonne is imported.

India imports about two million tonnes of pulp (soft wood and hardwood) and waste paper (sack
waste for unbleached grades, envelopes waste, cup stock for white grades and magazine waste) for newsprint.

The paper industry in India looks extremely positive as the demand for upstream market of
paper products, like, tissue paper, tea bags, filter paper, light weight online coated paper, medical grade coated paper, etc., is growing up.

The following prime grades of paper are imported from USA, Europe, Dubai and Singapore:
label stock, wet strength papers, tea bag tissue, soft tissue, filter paper, insulation kraft, extensible kraft, decorative laminates, overlay tissue, thermal papers, digital papers, coated papers/boards and some specialities. Stock lots of all grades totaling about 200,000 tonnes arrive every year mostly from USA and Europe. These are imported by traders in major metro cities of Mumbai, Chennai, Cochin, Bengaluru and Delhi.

India has surplus to export some grades. It exports following grades of papers to Middle East,
South Eastern countries, Eastern Europe and USA: A4 copiers, wood-free (mostly from bamboo and agro waste by several small mills), MG varieties (from small agro based mills), coated duplex (mostly recycled fibre) and large quantity of converted products like stationery items, calendars, books, magazines, childrens play books and comics.

_____________________________________________ The Issues:

Major issues confronting Indias pulp and paper industry are high cost of production caused by
inadequate availability and high cost of raw materials, power cost and concentration of mills in

one particular area, non-availability of good-quality fibre, uneconomical plant size, technological obsolescence and environmental challenges, highlighted the ASSOCHAM paper.

The cost of wood to Indian players is $50 per metric tonne compared to around $30
internationally. While issues related to technology, capacity and environment come directly under the purview of companies, raw material shortage is a disadvantage affecting all domestic companies.

Indian paper industry can be more competitive by adding improvements of key ports, roads and
railways and communication facilities, revision of forest policy is required for wood based paper industry so that plantation can be raised by industry, cooperatives of farmers, and state government. Degraded forest land should be made available to the industry for raising plantations. Import duty on waste paper should be reduced, duty free imports of new & second hand machinery/equipment should be allowed for technology up gradation.

There are not many mills that have integrated wet-end systems in the overall control strategy.
The paper mill is the formative stage in a paper making process and any forward control strategy results in impressive gains in terms of quality. Likewise, energy, being the significant portion of production cost, is getting less attention in terms of monitoring the overall consumption of power across various sections of the plant.

Integration of electrical systems, including intelligent motor control centers with mill distributed
control systems (DCS), will help in monitoring the overall energy consumption. Another area is integration of raw material flow information on real-time basis and utilizing the same to effectively control the quality at various stages.

Enterprise solutions, such as enterprise resource planning systems, manufacturing execution

systems or collaborative production management systems, and supply chain management systems have not received adequate attention from the paper industry management. Also there exists a lack of coordination between the automation department and IT within the mill. As a result, the pulp and paper industry in India lags behind its Asian and global counterparts.

Collaborative production management systems will improve the mill management and business
systems radically. Quality control labs with statistical models can be linked to give advantage to both production and quality control personnel. Dealers and end users can track their orders as the product moves through various stages of production.

Businesses will not survive with just traditional automation systems. Only integrated automation
and enterprise systems will enable these industries to achieve sustainable competitive advantage.

Essentially, there is a huge potential for automation and system integrators to work
collaboratively with Indias pulp and paper companies and help them acquire the competitive edge. This means paper mills in India have tremendous opportunity to improve their profit

margin by increasing their investments in automation systems and enterprise solutions, and integrating them to achieve collaborative production management. With the countrys economy growing robustly, the paper consumption in India is bound to expand, and the existing gap is a good indicator of the industrys growth potential. ______________________________________________________________________________

The Major Players:

000 tonnes Ballarpur Industries* Hindustan Paper Corp ITC Tamil Nadu News Print JK Paper Khanna Paper Mills Rama Newsprint & Paper Mills West Coast Paper Mills Andhra Pradesh Paper Mills Seshasayee Paper & Boards Orient Paper & Ind Star Paper Current Capacity 530 370 403 245 Capacity Additions By Leading Players* Capacity Cost of Year of Purpose Post Capex Capex (Cr) Commission 730 1260 FY09 Paper Capacity 700 2500 FY09-10 Paper & Pulp Capacity 630 2500 FY10 Paper & Pulp Capacity 365 1215 FY08 Paper, Pulp capacity & Captive power 345 120 FY08 Packaging Board 310 270 FY09 Paper Capacity 300 400 FY08 Paper & Pulp Capacity 285 1100 FY09 Paper, Pulp capacity & Captive power Paper, Pulp capacity & Captive power Paper & Pulp Capacity Paper & Pulp Capacity Paper, Pulp

195 290 132

164

154

200

635

FY08

115 171 80

175 186 150

250 750 400

FY09 FY10 FY09

Mills

capacity & Captive power *Source: This is from the report Paper Sector: Changing Script, by ICICI direct.com, dated June 29, 2007 (analyst: Himani Singh) ______________________________________________________________________________

Demand outstrips Supply:

As the following graphs -- from a very definitive report released in July 2007 show, Indian
paper industry demonstrates the classic demand-outstripping-supply scenario. Analyst Himani Singh, in her report, Paper Sector: Changing Script, (released by ICICI direct.com, dated June 29, 2007), forecasts a robust demand scenario for the industry. She writes: We see demand for paper growing at a robust CAGR of 6.6% and are optimistic in the long term as key demand levers such as rising GDP, increased literacy spending and improving per capita consumption are in place.

We are sanguine about the demand numbers as India consumes only 1% of the worlds paper
produce. Per capita consumption is low at 7 kg. The impact of just 1kg increase in per capita consumption would lead to increase in demand by 1.1 million tonnes of paper. We do not foresee a glut in the market .

In the long-term, Asia will continue to be a major growth driver in the global paper industry. The
Indian paper market is growing at 3x the global average and 50% more than Asian average. Demand is over encouraging and good traction is seen in the high value added segment. [see the following two graphs] Demand Outstripping Supply*

* The grey line stands for Supply (CAGR 6.2%). Its not clear in the graph.

Demand Overshoots Supply

Writing on some of the current trends in the industry, Himani writes that there is a clear shift to
value-added high margin products. Clear growth is being seen in the writing and printing and the high value added segments. Coated paper is growing at 9%, while the copier paper segment is growing at a robust 15%. Most capacities are getting added in these segments and are set to result in improved realizations for the players. [see the following graph & table] Writing & Printing Paper Segment & Growth FY06-07

000 tonnes Creamwove Maplitho Copier Coated paper Industrial paper Specialty

FY01 FY02 Inc% 1,015 1,056 4.0% 475 494 4.0% 68 80 17.6 % 204 222 8.8% 2,672 2,809 5.1% 180 191 6.1%

Product Wise Demand FY03 Inc% FY04 Inc% 1,094 3.6% 514 4.0% 94 17.5 % 242 9.0% 2,985 6.3% 205 7.3% 1,135 3.7% 547 6.4% 110 17.0 % 270 11.6 % 3,168 6.1% 221 7.8%

FY05 Inc% 1,185 4.4% 574 4.9% 127 15.4 % 292 8.1% 3,376 6.5% 239 8.1%

FY06 Inc% 1,232 3.9% 601 4.7% 147 15.7 % 317 8.5% 3,600 6.6% 258 7.9%

FY07 1,281 631 170 346 3,819 277

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Sources:
1. Fitch Ratings press release (www.fitchratings.com) 2. Business Standard (India) (www.business-standard.com) 3. Indian Paper Manufacturers Association (http://ipma.co.in/) 4. ASSOCHAM 5. ICICI direct.com 6. Media & industry reports (India)
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