Orient paper and industries

Orient paper is worth a look because:

1). It has emerged from demerger recently, where the more profitable cement business has been demerged.

2). It is a penny stock (trading at 7-8 currently). I love good penny stocks, there is an inherent inefficiency as most institutions (MFs etc.) are not allowed to buy these stocks.

I’m talking about the business that remains after cement demerger. Consists of two businesses actually:

1). Electricals - fans, CFLs etc. (PBT - 50 cr FY2013)

2). Paper (LBT - 80cr FY2013)

Total market cap: 150-160 cr currently.,

Debt: 350 cr. (Breakup is not given but my guess is this is mostly for the paper business)

The former is a business with great economics, low capital requirements and good returns. In my opinion this is one of the manufacturing sectors which will continue to do well for obvious reasons (people will continue to buy and replace these products). In addition, due to low technology and R&D requirement, moat in this business comes from established brand and good distribution network (Orient has both). This is a cash cow business, closest to the Sees Candy of Berkshire Hathway.

BUT, the problem is the paper business. Has been making losses for the past three years. Other paper makers are doing OK, none of the big ones are making losses at least. But frankly, i dont know much about the paper business and would request for some help if others have done some work on this company. If the paper business recovers, its a great buy at current prices. But if it continues to make losses, might drag down the rest of the business with it. Any help/ views/ suggestions are appreciated.

Thanks.

2 Likes

Hello Kashif,

Totally agree about the electrical business being great.

However, the paper business has been suffering massively, mainly due to shortage of water, which they say is now being sorted out.

Also, do bear in mind that there is a very large demand for Water Tax (Rs.280 cr) against the company which is under arbitration. This has not been provided for in the books, hence is not visible in the financials.

With reduced imports understand that rates for writing & Printing paper recovering gradually.

Hi, I think its a classic demerger play. DIIs selling out low market cap company. So price will be kept down for quite sometime (probably till oct). Domestic Institutions hold 30% still. Management is trying to turn-around paper business. So should not be a huge concern

If management was really confident that paper business will turn around in near future, they might have separated the electrical division too, as on a standalone basis it might have commanded a better valuation. My GUESS is because of contingent liability and losses in paper business, cash inflows from electric division will get wiped out. Domestic institution still hold 30%. They might be desperate to exit and they might sell at very increase in price or increase in volumes. Off late I realized that in Nano cap stocks desperate selling by institutions can result in steep decline in price when business fundamentals of the company already are not so good…

With the latest set of results, paper business has turned around. So now the concerns should be resolved right?

I guess so, although i have not started a position in this stock yet but i’m looking at it again. The risk reward situation is definitely getting better.

Last qtr results:

Revenues:

Paper - 97.88 crores compared to 81.62 crores last year june qtr - 20% up

Electrical - 206.85 crores compared 184 crores last year june qtr- 12.4% up

P/L before finance costs:

Paper- 3.07 crores compared to loss of 15.88 crores last year june qtr

Electrical - 10.6 crores compared to 6.7 crores

It looks like paper division will maintain profitability this year as power/water problems got resolved.

At current market cap 125 crores, it looks undervalued. If paper business continues with profit and electrical business maintains growth of 15-20%, then I think there is a good value in this stock at this price

Just saw this notification in BSE:

Orient Paper & Industries Limited has informed the Exchange that the Board of Directors of the Company at its meeting held on September 03, 2013, inter-alia, decided to set up a LOW VOLTAGE SWITCHGEAR PROJECT with a capacity of 2 million Poles of MCB s at the Company s Electricals Division at Noida at an estimated capital outlay of Rs. 25 crores.

look what happened here… both the demerger opportunities highlighted by me (orient and vardhman special steels) have behaved like any other demerger play… they went down first and then quickly recovered … this one is already 4-5 bagger…

Hi,

Any idea/info on why their paper losses in H1’15 jumped so high (higher than last full year losses)?

rajat

This stock was amazing at 4.55rs/share. Its valuation of the plant and machinery itself was significantly higher than market cap lol.

It shot up from 4.55rs to 30-33rs/share. Now the story is over for good. Losses are widening.

Jump ship.

neil these lossees are widening because of one -offs - Rs. 25 cr. marketing campaign in rebranding orient fans into orient electric and one off issues on the paper business.

Infact, this provides a good entry point IMHO

Orient paper – don’t throw the baby triplets out with the bathwater

((1 USD = INR 63.75))

CMP – INR 27.1 ((USD 0.425)) –
Target Price – INR 80 ((USD 1.25))

Having learnt from both Warren
Buffet and Phil Fisher, I have developed my own unique style of stock analysis
– that involves about 40-50% of analysis on the ground (which a lot of analysts
miss out on) the rest in desk research- reading AR’s, analysing numbers etc. I
would like to call this the Holmesian way of analysing stocks - unlike
conventional analysis that relies heavily on secondary research, this creates a
double loop mechanism that feeds into the other engine and helps validate or
reject the thesis. This has often proven to be quite an advantage in micro caps
where often “what you see is not what you get in the numbers” and vice versa.

Said all of this, it is seldom
that I come across a stock that is a purists value investor’s delight which
offers a triple play of reversion to mean, de-merger/spin-off optionality and
pure and simple undervaluation. I must thank my friend, Rohit Balakrishnan who
introduce me to this stock and also shared his note with me from which I have
generously borrowed.

Company background – diamond embedded in a silver bar obfuscated by
dirt

The company is Orient Paper and
Industries – OPIL for short, (NSE: ORIENTPPR) and is a small/micro cap with a Market
cap of INR 5, 570 MM ((USD 87.1 MM)) with no analyst following (don’t I just
love these) and of course low liquidity and institutional interest.

The company, which is a part of
the CK Birla group of companies (which is quite a respected 100 year old
business family in India known for its governance and ethics, albeit a little slow
to change) is the residue of a de-merger from a parent that consisted of
Cement, Paper and Electrical appliances in March 2013. The new-born child, Orient Cement (NSE:ORIENTCEM)
has generated 6 x in a little more than two years and now trades at a Mcap of
USD 558.9 MM ! Point to note is the the Mcap of the mother entity before this
de-merger entity happened was a little less than $ 150 MM.

As is the case, given that the
cement business is monoline and has critical mass, all institutional attention
is focussed on it – the newly born, sexy child. As it always happens with
de-mergers/spin-offs, the mother business, which ironically houses a wonderful 25
% ROCE business of electrical appliances (“Orient” Brand of home and kitchen
appliances which is a market leader) has been obfuscated by the other tantrum
throwing difficult child – the paper business which is coming off a trough
(‘reversion to mean’) and is likely to see much better times in the next 1-2
years.

Triple play – tails I can’t lose much, heads I win big, really big

OPIL is a combination of two
intrinsically different businesses that have vastly different characteristics
and leads to a quadri play of:

·
Reversion
to mean: A cyclical business coming off a trough and a secular growth
business (the home appliances business) coming off a one-time expense ( a INR
500 MM (USD 7.8 3 MM)

·
Spin-off/De-merger
play: Given that there has already been one de-merger that has happened
from this business, I believe that the chances of another de-merger happening
and value getting unlocked by the consumer appliances division are extremely
high. The management has done it before and has seen the manifold value that
has been created two years back and I see no reason why they would not do so
again. The last de-merger unlocked about $ 600 MM of Mcap out of thin air and a
cat that has distilled out a sweet pudding from the same dish is likely to do
so again.

·
Embedded
value: OPIL holds about INR 2,500 MM
(USD 39.2 MM) of shares of Hyderabad Industries Limited (India’s largest maker
of fibre cement sheets and concrete blocks) and Century Textiles (an ailing
textile mill that is on the process of being sold). It holds about $ 9 MM of shares
(which is 16% of the company) at cost in GMMCO (India’s largest dealer of
caterpillar equipment http://www.gmmco.in/GMMCO/
with sales of USD 400 MM) that is worth at least $ 40 MM in book value as the
company generates about $ 25 MM of profits. On top of it, the company now owns
a now defunct paper mill in Brajrajnagar with an estimated market value of land
worth at least INR 1,000 MM ((USD 16. 6 MM)). These alone provide about 30-35%
of the value at CMP (about INR
5-7/share)

·
Plain
undervaluation: The business is trading at 1 x FY 15 book value and I
expect the business to do about 12% RoE blended in FY 17 from the core business
without taking into consideration the above mentioned optionality.

Business analysis:

OPIL has two businesses – the
electric appliances division (that’s a high RoCE jewel) and the paper division (that
barely covers its cost of capital and is a declining “dog” business)

Electric Division

Paper Division

Products offerings

Fans, CFL bulbs, luminaires, home

Writing and printing (W&P) paper,

Appliances (air coolers, toasters etc.

tissue paper

Revenues 9M FY 15 E

INR
10,530 MM (USD 165 MM)

INR 3,386 MM (USD 53 MM)

Revenue growth (estimated over the next 3
years)

20%

4%

EBITDA ( 5 year average)

7%

-3%

ROIC ( 5 year average)

25%

-6%

FY 17 E ROIC

22%

8%

  • Fans 73%, lighting 15%, home

  • W&P paper 70%, tissue paper

appliances 12%

30%

Revenue split

  • Ceiling fans account for 80% of

  • 50% of tissue paper is exported

fans revenues

  • CFLs account for 82% of lighting

Revenues

Fans (domestic) - 2nd largest

Tissue paper - amongst the leading

overall and largest in ceiling fans

exporter from India

Market position

with 25% market share

Fans (exports) - largest exporter

from India

Brands

Orient

1st
Choice, Orient, Diamond Touch

Capacity

Fans – 9
MM units

W&P
paper - 60k tons

CFLs -

10 MM units

Tissue
paper - 25k tons

Analysis of the two segments of business

Revenues
(INR Cr)

Segments

FY07A

FY08A

FY09A

FY10A

FY11A

FY12A

FY13A

FY14A

7yr CAGR

Paper

263

274

290

239

278

334

349

430

7%

Electrical

243

285

341

481

642

756

912

1139

25%

EBIT Margins

Segments

FY08A

FY09A

FY10A

FY11A

FY12A

FY13A

FY14A

7yr avg

Paper

10%

1%

-18%

-12%

-19%

-22%

-3%

-9%

Electrical

8%

10%

13%

9%

7%

6%

6%

8%

ROCE

Segments

FY08A

FY09A

FY10A

FY11A

FY12A

FY13A

FY14A

7yr avg

Paper

17%

1%

-14%

-10%

-15%

-17%

-3%

-6%

Electrical

25%

30%

43%

28%

21%

19%

18%

26%

Note the reversion to mean in the
paper business – management has guided to an EBIT breakeven in FY 15 and my
sense is that this business will generate a 4-5 % EBIT next year, which should
help it generate close to 6-7 % ROCE going up to about 10% by FY 17.

Also, the electrical appliances
business’s ROCE has been dragged down by a rebranding one ime expense of INR
500 MM (USD 7.83 MM) that should start
yielding results over the next 2-3 years and hence should improve ROCE’s to the
20-25% range.

Electrical appliances business

To triangulate and validate the
academic hypothesis that the business is doing well, I spoke to a mid-level
employee in the electrical appliances, a couple of dealers and an employee at a
competitor. The distillation of their views is as follows:

The Orient brand is synonymous with fans and
association of India’s wildly successful cricketer Dhoni has helped build a lot
of brand recall. In fans, especially in Southern India, they are very strong
and have a lot of pricing power. Orient is the undisputed leader in premium
fans a fact acknowledged in the annual report of its closest competitor
Crompton Greaves.

The “fans” association has helped them in their
foray into air coolers where there has been early traction. This should help
them as the average price of an air
cooler is 5 x that of a fan and air coolers is a relatively less competitive
category

Channel checks point to a 20-25% growth in the
years ahead. Given the natural operating leverage in the business (since
manufacturing is outsourced), this should translate to a 100-200 bps in the
EBITDA

The company has put in place a new factory for
low voltage switchgear (Business News Today: Read Latest Business news, India Business News Live, Share Market & Economy News | The Economic Times)
which should provide an optionality. LV switchgear has been a high margin, high
ROCE business for everyone in India (Havells, Legrand, Schneider etc.) and the
company should be able to grab marketshare here.

Electric’s revenue mix%

Products

FY11A

FY12A

FY13A

FY14A

Fans

91%

87%

81%

73%

Lighting

9%

12%

14%

15%

Appliances

0%

2%

6%

12%

A point to note is that the
capital employed in this business went up in the last two years as the company
has invested into an extra factory and also on brand building – the company
spent more than INR 500 MM (On the electricals business) and this should come
back to mean ( ~ 25%) by FY 17 or so as
the effects of branding start playing out on sales.

On the paper business

India represents a pretty unique
market where demand for paper continues to grow at 3 % primarily the back of
increasing literacy levels on the back of more than 400 million below the age
of 25. As the above link distils out, a lot of the overcapacity issues
involving the paper industry are bound to go away over the next 2-3 years as no
industry player is looking at adding capacity. Given that, I think the industry
will eventually get back to a state where each player earns a little above the
cost of capital – viz., say ROCE of 11-12 %. Even so, I expect cost pressures
to be a significant risk for OPIL given the increasing issues involving water,
which is becoming scarce. Overall, I expect no excitement in this business
except for a return to recovering cost of capital by FY 17, which will be a
about 8-9 years after the beginning of the reduction in supply.

Paper sales volume mix

Products

FY07A

FY08A

FY09A

FY10A

FY11A

FY12A

FY13A

FY14A

W&P paper

89%

90%

90%

85%

77%

74%

74%

69%

Tissue paper

11%

10%

10%

15%

23%

26%

26%

31%

The company has been well managed
and has been known for its governance standards over the years. Case in point, is
the de-merger of the cement business which was done through a classic mirrored shareholding thereby
protecting the interests of minority shareholders.

Valuation and returns analysis

We have valued OPIL using sum of
the parts (SOTP) methodology. We have tried to calculate EV of both the
businesses – paper and electric – separately. Long term debt has been divided
in the ratio of gross block of two divisions and working capital debt net of
cash has been divided in the ratio of revenues of two divisions. We have valued
paper business at half time its capital employed to calculate its EV and have
accordingly arrived at its equity value of INR 870 MM ((14.7 USD)) which I
believe is quite conservative given that the ROIC should near cost of capital
by FY 17 and valuing it at 0.5 capital employed gives quite a margin of safety.

The electric
business is hugely undervalued by any metric – comparables, market value of
electric division at 457Cr. Next, we have valued electric division, on a
certain set of conservative assumptions and have arrived at its intrinsic
valuation. OPIL’s electric business seems to be trading at a ~55% discount to
its intrinsic valuation of 1,017Cr.

Paper

INR MM

Capital employed (CE)

4, 080

As on Q3’15

Multiple of CE

0.5x

Conservative assumption

EV

2,040

Net Debt

1,180

Intrinsic equity value – A

870

Electric

TTM Sales

12,180

As on Q3’15

EBITDA margins %

8%

Based on peer set

EBITDA

97

EV/EBITDA multiple

12x

5yr median multiple of peer set
is 14.2

EV

11,690

Net Debt

1,530

Intrinsic equity value - B

10,170

Total Intrinsic equity value – A + B = 870 + 10,170 = INR 11,040 MM ((USD 173.4 MM))

Current Mcap = INR 5,560 MM ((USD 87.2 MM))

This indicates a 50% discount to
intrinsic value assuming no growth and at today’s numbers and points to an IRR
of 25%. This, of course does not factor in the embedded value of INR 6-7/share
of holdings in Hyderabad Industries Limited, GMMCo and Century textiles.

Optionality – Future returns

Please see below for workings on
returns analysis -

Assumptions

Growth in electric division

25%

growth in home appliances,
launch of new products and recovery in fans division – in line with past
performance and with peers

EBITDA margins

8%

EV/EBITDA multiple

12

Investment horizon (yrs)

3

Net Debt (Cr)

284

same as Sep 2014 as there
should not be any further requirements of capital

             Electric

INR MM

TTM revenues (Q3’15)

12,180

Revenues - FY18 P

23,790

EBITDA- FY18

1,900

EV -FY18 (A)

22,840

Paper

EV -FY18 (B)

2,040

same as assumed to be today

OPIL

EV -FY18 (A+ B)

23,710

Equity value -FY18 – ( C )

22,050

CMP INR

27.15

CMP at (
C ) INR

107.1

IRR

57%

In summary, as the graph below shows, OPIL is a classic quadri play of
the following:

·
One high quality business hidden inside an
average business leading to a de-merger/spin-off play with a clear and present
catalyst

·
Cyclical turn around in one business and secular
growth in the other

·
Reversion to mean

·
“one-off” expenses dragging down earnings
temporarily (re-branding costs)

·
Deep value – trading close to book value

Why does this opportunity exist?

Because this business being a mix
of two diverse businesses has no tracking from analysts following paper (paper
business is sub scale) or electricals (numbers are difficult to fathom as they
are clouded by the paper business). Add to that the micro-cap nature and losses
in the business (which take some time to peel through).

Risks and concerns

Given that this is a long term
play, I am also cognizant of the following risks and have put in place
monitorables to keep track of progress and effect course corrections :

·
Paper division’s
losses do not shrink –Though this
division is no more incurring cash losses, which is a big improvement over last
2 years, it still does not pay back its cost of capital and here any upside
from monetization of land and improving efficiencies would be greatly helpful.
Also, for the de-merger to happen, it is imperative that the paper division
stand on its own legs and hence, this is the biggest risk I see to this thesis.
However, given the cyclical trough, lack of capacity addition in the industry
and a slow pick up in volumes, this should improve over the next two years.

·
Pricing pressure in
electrical appliances – There are
over 15 branded players in the home appliances market making it highly
competitive resulting in lower profitability for these players.

·
Contingent
liabilities on account of water tax liabilities – There is an old tax dispute going on between OPIL and
government of MP. Original amount of tax liabilities was less than INR 100 MM ((USD
1.6 MM)) has grown to INR 3,500 MM ((USD 55 MM)) over a period of 30
years. The company has disputed the same
in a court and the decision is pending. We draw some comfort from the fact that
original liability in this case is very small and these type of disputes tend
to be settled closer to the original claim eventually.

Orient Paper Investment Note.pdf (434.0 KB)

2 Likes

@varadharajanr Your write-up was very good and read it in seeking alpha… I hold this stock from low levels… I feel Paper is a drag and another demerger has to happen to realize the full potential… But, the MD clearly said in a recent call that they are expecting better times in FY2016… Let’s see whether it happens or not… He has been telling that Paper will do better for the last few quarters…

URL for MD’s interview: http://www.moneycontrol.com/news/results-boardroom/targetingpositive-bottomlinefy16-orient-paper_1381677.html

1 Like

Hi Varadha, did you have a chance to look at the quarterly result? The finance cost has dragged down the profit to loss. Otherwise they have made a profit compared to last year of same quarter. What would be your views?
Disc-Not invested.

Very disappointed with the management’s attitude towards shareholders. in a year in which their losses were Rs 45 cr, the CEO paid himself a 50% increase from Rs. 2 Cr. to Rs. 3.3 Cr.

The losses are the same as last year as they had a Rs. 24 Cr. one time branding cost on orient electricals. This is a classic example of how capital allocation to a weed (the paper business) can slowly start destroy the cash crop (electricals - their electrical margins are steadily declining over hte years and capital efficiency is dropping).

Said all of this, I am holding - in a falling commodity price environment, the paper biz should benefit.

Like marlon brando said “orient electricals could have been a contender but they chose to blow it”. companies like bajaj electricals and crompton have surged far ahead - seems like the story of a good boy at school who got influenced by a dope peddler and become a mediocre.

Very disappointed with the CK birla groups capital allocation capabilities.

3 Likes

have you had a look at the q3 results? any positive turnaround that you anticipate?

Demerger is announced and as per the available info, electrical unit will be demerged and will be listed separately. Mirror shareholding structure will apply as was the case when orient cement was demerged.

Debt distribution b/w two businesses will be decided on a later date but total debt of 420Cr will come down by 50Cr from proceeds of the announced rights issue of 50Cr. Electrical business will get only its core assets. All other assets and investments will be transferred to paper business. Company has 120Cr of century textile shares and 50Cr of HIL shares and 500Cr of land which will be transferred to paper business. In a recent concall, management said century investment is not strategic in nature for them.

Talking of specific businesses, paper seems to be improving now on the back of 1) cost control measures taken by company 2) improving supply scenario in writing and printing paper space. Another positive for the company is increased capacity in better margin tissue paper, which is now 50,000 MT, revenue potential of 300Cr. this takes the total revenue potential of the company to ~700Cr. However, company is still affected badly by shortage of water and Q1 of 2017 witnessed losses once again because of this problem. In the same concall, management said EBIT margins of 10-12% are doable for this unit, i’ll take that with a pinch of salt. Net net, this business is not an attractive one despite it achieving 12% EBIT margins as ROCE will still be below 15%. I’d give this business a valuation of 200-250Cr (based on 12% EBIT margin (highly improbable in my view) and a PAT multiple of 8x).

Company’s electrical business seems to have improved its profitability but growth is still lacking. Orient is lagging behind it competitors, Havells and CG on growth as well as margins. I cant understand why is company not able to grow despite having such a solid brand. However, expected slowdown in real estate will pose growth challenges to its already slow growing fans division, major contributor to profits of the company. Surprisingly, company has done very well in its LED business though margins would be very low there as most of the sales were mainly done for EESL orders. Home appliances have also disappointed in terms of topline no, sales of ~80Cr since its launch ~4 years back. This probably shows highly competitive nature of business alongwith slowdown in consumer demand over last few quarters. Or it could also mean management is not aggressive enough. Future growth prospects do not seem to be exciting.

Valuation for the combined entity has increased a lot in last few months and there is low margin of safety at the moment.

The operating cash flows of the company is a key monitor-able. I think you are right that there is not much value at these levels. The paper division even if its manages to earn 8-9 per ebidta margin wont generate more than 20-25 crs in pat.and at a pe of 8 or 10, 250 crores is a fair market cap. though it will have almost 100 crs in shares of other birla cos and a good 800 acres land bank which is worth 500 crores but dont expect any action on that front soon.

The electric division, after demonetisation might face some problems. Fan industry might stagnate and not show any meaningful growth for the next year or two. Similar is the case with appliances and switchgear division. At best it does 5-6 per ebit margin on a 1300 cr turnover.

What do you think the growth prospects are for the electric division over 3-5 years?

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