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Seshasayee Paper and Boards Ltd: Fundamental Analysis

The current section of the “Analysis” series covers Seshasayee Paper and Boards Ltd, a leading Indian paper manufacturer.

The “Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.

Please note that to get maximum benefit from this article; an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.

Seshasayee Paper and Boards Ltd: Detailed Fundamental Analysis

In the past, on various occasions, Seshasayee Paper and Boards Ltd has acquired stakes in many companies, which have been its associates and subsidiaries. As a result, in FY2013 and thereafter, from FY2015 onwards, it has reported both standalone as well as consolidated financials.

On March 31, 2023, the company had one subsidiary, Esvi International (Engineers & Exporters) Limited and one associate company, Ponni Sugars (Erode) Limited (March 2023 quarter results, page 17).

We believe that while analysing any company, an investor should always look at the company as a whole and focus on financials, which represent the business picture of the entire company including its subsidiaries, joint ventures etc. Consolidated financials of a company present such a picture. Therefore, if a company reports both standalone as well as consolidated financials, then the investor should prefer the analysis of the consolidated financials of the company.

As a result, while analysing the past financial performance of Seshasayee Paper and Boards Ltd, we have analysed the standalone financials of the company from FY1996 to FY2012 and for FY2014. In addition, we have analysed consolidated financials for FY2013 and from FY2015 onwards until Dec. 2022.

Further recommended reading: Standalone vs Consolidated Financials: A Complete Guide

With this background, let us analyse the financial performance of Seshasayee Paper and Boards Ltd.

Seshasayee Paper And Boards Ltd Financials FY2014 FY23

Financial and Business Analysis of Seshasayee Paper and Boards Ltd:

In the last 10 years (FY2014-FY2023), the sales of Seshasayee Paper and Boards Ltd have increased at 9% year on year, from ₹996 cr in FY2014 to ₹2,083 cr in FY2023. At times, the company saw its sales decline like in FY2018, FY2020 and FY2021.

Over the years, the operating profit margin (OPM) of Seshasayee Paper and Boards Ltd has seen high fluctuations. The OPM declined in FY2013 to 9% from 12% in FY2012. Thereafter, OPM improved to 23% in FY2020. However, it soon declined to 12% in FY2022. In FY2023, the OPM increased to 26%.

Net profit margin (NPM) follows a similar trend and has fluctuated between 2% in FY2015 and 19% in FY2023.

We have expanded the period of analysis of profitability to the last 28 years (FY1996-FY2023) to better understand the profitability patterns of Seshasayee Paper and Boards Ltd. The following table shows the trend.

Seshasayee Paper And Boards Ltd Net Profit Trend FY1996 2023

An investor notices that during the last 28 years, Seshasayee Paper and Boards Ltd had large fluctuations in its net profit margin (NPM). NPM used to be 17% in FY1996, which declined to 1% in FY1998, stayed at similarly low levels and at 1% in FY2002. NPM increased to 6% in FY2004 only to decline to 2% in FY2005. It increased sharply to 10% in FY2007 but declined sharply to 3% in FY2009. NPM increased again to 11% in FY2011 but declined to 2% in FY2013 and stayed at similarly low levels of 2% in FY2015.

Thereafter, NPM increased to 15% in FY2020 and then declined to 8% in FY2022. Now, NPM has shown a sharp recovery to 19% in FY2023.

To understand the reasons for such a financial performance of Seshasayee Paper and Boards Ltd, an investor needs to read the publicly available documents of the company like its annual reports from FY1997 onwards, credit rating reports by CARE, corporate announcements as well as other public documents.

In addition, an investor should also read the following article explaining the key factors affecting the business of paper manufacturing companies: How to do Business Analysis of Paper Manufacturing Companies

The above-mentioned documents show that the following key factors influence the business of Seshasayee Paper and Boards Ltd, which are critical to understand for any investor analysing the company.

1) No pricing power over its customers due to the non-differentiable commodity nature of paper products:

Seshasayee Paper and Boards Ltd makes paper products, which are difficult to distinguish between different competitors. There are specified grades of paper used in different applications and within the same grade, a customer can easily replace products of one paper manufacturer with another.

For example, if a customer needs a copier paper of 75 GSM (grams per square meter), then she can easily use 75 GSM paper from any of the manufacturers without a significant impact on usability. Or, a person can replace the notebook of one paper manufacturer with another easily without any significant impact on her writing ability.

One of the reasons for the non-differentiation of products by Seshasayee Paper and Boards Ltd is very low spending on product research and development (R&D). In FY2022, it spent ₹0.8 cr on R&D, which is 0.059% of its revenue of ₹1,355 cr in the year (FY2022 annual report, page 106).

Instead, the company along with the Indian paper industry relies on the Central Pulp and Paper Research Institute of the Indian Govt. for innovative research in paper products.

Transcript of AGM, July 2021, page 21:

On the research side, Paper Industry has got a centralised research facility at Central Pulp and Paper Research Institute at Saharanpur…We don’t do fundamental research in paper units.

As a result, paper manufacturers do not have any pricing/negotiating power over their customers. A customer can easily switch from one paper manufacturer to another.

In the case of Seshasayee Paper and Boards Ltd as well, over the years, many disclosures and explanations provided in its annual reports show that the company does not have any pricing power over its customers.

Seshasayee Paper and Boards Ltd is not able to pass on an increase in its input costs to its customers. As a result, on multiple occasions, its profit margins suffered when costs increased.

For example, in FY1997, the company’s profitability suffered when costs increased a lot and it could not pass them on entirely to its customers. Its NPM declined from 17% in FY1996 to 6% in FY1997.

FY1997 annual report, page 5:

Gross profit before interest and depreciation was lower…caused by cost escalations with no matching price increases of end-products due to unfavourable market conditions.

On similar lines, in FY2018, the company could not get an equal price increase when its input costs increased. As a result, its NPM declined.

FY2018 annual report, page 11:

The Company could not pass on fully the cost increase arising out of steep increase in the prices of Coal, Furnace Oil and other input chemicals during the year.

The recent sharp decline in the profitability of the company in FY2022 when its NPM declined to 8% from 14% in FY2021 was because it could not get a price increase proportional to cost increases.

FY2022 annual report, page 37:

Coal prices are now at 3 times the pre-covid levels…All these have resulted in significant pressure on margins, with Price increases in Paper not meeting the impact of cost push in full.

These are examples of the years when Seshasayee Paper and Boards Ltd could not increase its prices sufficiently to cover its costs. However, there were many years when it had to reduce prices even when the input costs were increasing.

In some of these years, Seshasayee Paper and Boards Ltd reported very low profitability margins.

For example, in FY1998, it could barely manage to avoid loss and its NPM declined to 1% when its costs increased; however, its sale prices declined by about 8%.

FY1998 annual report, page 3:

Gross sales realisation declined by around 8%…in the current year. On the other hand, there was a further escalation of costs.

In FY2002, the company’s NPM again hit a rock bottom of 1% when its costs were increasing; however, sales prices were declining.

FY2002 annual report, page 17:

units in the industry were unable to effect any increase in prices of their products, even to meet, partially, the increase in costs. On the contrary, there were frequent price drops

The absence of pricing power of Seshasayee Paper and Boards Ltd has hurt it decade after decade. In FY2012, its NPM declined to 6% from 11% in FY2011. The company suffered this decline in profit margins because it had reduced its prices even when it faced significant increases in costs.

FY2012 annual report, page 27:

Major factors that impacted the profitability were the steep increase in prices of input materials…Further, the unfavourable market conditions forced the Company to reduce its prices consistently.

Seshasayee Paper and Boards Ltd continued to suffer due to increasing raw material costs where it had to reduce prices to sell its goods. As a result, in FY2015, the NPM of the company declined to 2%.

FY2015 annual report, page 12:

Overall Profit before tax for the year registered a steep fall…when cost increases could not be passed on to the customers and discounts had to be offered to push-up sales

At times, the company has faced such a low bargaining position in front of its customers that it had to incentivize them by offering additional offers like a higher credit period. For example, it happened in 1998.

FY1998 annual report, page 4:

There was unabated pressure on paper prices throughout the year. It also became neccessary to offer extended credit period to push the products into the market…The net sales realisation for the Company fell by Rs 1000 to Rs 1500 per tonne

An investor would appreciate that such low bargaining power of Seshasayee Paper and Boards Ltd is due to intense competition in the industry.

Recommended reading: How to do Business Analysis of Steel Companies

2) Intense price-based competition in the paper industry:

The paper industry in India is highly fragmented with many small and big paper mills competing for business. In addition, Indian paper mills face intense competition from overseas players, both in finished paper as well as pulp segments.

Let us understand why the Indian paper industry faces such intense competition.

2.1) Competition from Indian paper manufacturers who compete mainly on price:

Indian paper industry is facing an oversupply situation where domestic paper production capacity is much higher than paper demand. In 2019, India’s domestic production capacity was 25.17 MTPA.

FY2019 annual report, page 23:

there are over 800 paper mills in operation in the country, with an installed capacity of 25.17 million tonnes and operating at over 80% capacity utilisation.

Indian mills are not able to run at full capacity because the market size of Indian paper demand in FY2022 was only about 18.6 MTPA.

FY2022 annual report, page 48:

IPMA estimates the domestic market size of paper to be around 18.6 million tonnes per annum.

Out of this, some demand is met by imports, which further restricts the market available for domestic producers. As a result, domestic manufacturers, which all produce non-differentiable, commodity products, compete intensely, primarily on price to gain business and keep their mills running.

Throughout its history, Seshasayee Paper and Boards Ltd had to face this intense price-based competition where it had to offer lower prices/discounts to sell its goods. It had to reduce its prices in FY2004 to generate sales.

FY2004 annual report, page 24:

prices were under tremendous pressure, due to competitor mills offering hefty discounts to push their products into the market. The Company had to offer price concessions for white varieties of paper in line with the market sentiments from January 2004 onwards

Seshasayee Paper and Boards Ltd had to reduce its prices in FY2012 to sell its goods to customers.

FY2012 annual report, page 12:

Also, the paper market was unfavourable…forcing the Company to reduce the prices of its products steeply in sympathy with the other players in the market.

Credit rating agency, CARE, has continuously highlighted the oversupply situation in the Indian paper market in its credit rating reports for Seshasayee Paper and Boards Ltd.

Credit rating report by CARE, March 2012, page 1:

ratings are however constrained by…the existing pressure on profitability margins due to over-supply scenario in domestic markets.

The company acknowledged in FY2013 that the oversupply situation in the market is hurting its ability to pass on increases in input costs.

FY2013 annual report, page 24:

margins would continue to suffer from high input costs and manufacturers’ limited ability to pass on such cost increases to customers due to over-capacity in the Industry.

The price-based competition faced by Seshasayee Paper and Boards Ltd is so intense that even news of a reduction in input costs like pulp is not very good news for the company. This is because it will have to pass on the benefits of such cost decline to customers by lowering its product prices due to competition.

Transcript of annual general meeting (AGM), August 2020, page 24:

Pulp prices are coming down. This is not necessarily a happy situation, since along with pulp prices, paper prices will also come down, which means we will be forced to down revise the prices.

The factors making Seshasayee Paper and Boards Ltd a price-taker are not limited to the overcapacity of Indian paper producers. Additionally, cheaper imports are also adding to the oversupply situation in India.

2.2) Cheaper imports put pressure on Indian paper manufacturers:

Apart from Indian paper manufacturers, the Indian industry faces intense competition from overseas manufacturers as well. This competition comes in both segments finished paper and pulp.

One of the main reasons for overseas paper manufacturers to target the Indian market is that it has shown good growth potential. Per capita paper consumption in India has grown from 5 kg in 2002 (Source: FY2002 annual report, page 16) to about 15 kg in 2022 (Source: FY2022 annual report, page 49).

This growth in paper consumption in India is despite increasing penetration of digital means like the internet, smartphones and computers.

Moreover, Indian per capita paper consumption is still low as compared to 65 kg of China and 312 kg of the USA supporting significant growth opportunities for players.

FY2022 annual report, page 49:

The per-capita consumption of 14-15 kgs is significantly lower than the world average of around 57 kgs…China’s 65 kg, Indonesia’s 22 kg, Malaysia’s 25 kg, and of course USA’s 312 kg consumption levels.

Indian paper manufacturers including Seshasayee Paper and Boards Ltd have been facing pressure from cheaper imports for a long time. In FY1997, rising imports of cheaper paper products were one of the reasons for the decline in the profit margins of Seshasayee Paper and Boards Ltd.

FY1997 annual report, page 6:

Throughout 1996-97, the paper industry was caught between rising prices of inputs and intense competition from paper coming from outside of India.

Even after more than two decades, in FY2018, Seshasayee Paper and Boards Ltd highlighted how cheaper imports are continuously putting pressure on prices in the Indian market.

FY2018 annual report, page 12:

market was flooded with imports of Copier and Maplitho grades from ASEAN countries taking advantage of the Zero Import Duty concession, at highly competitive prices, forcing domestic manufacturers to effect price reduction in these grades.

There are multiple reasons that Indian paper manufacturers like Seshasayee Paper and Boards Ltd are not able to compete with overseas players and lose out to them on pricing i.e. overseas players are able to sell their products cheaper in India.

2.2.1) Declining import duties by the Indian govt. on paper imports:

Over the years, due to treaties signed under World Trade Organization (WTO) and thereafter, under Regional Trade Agreements (RTA) and Free Trade Agreements (FTA), Indian govt. has reduced and even abolished import duties on the import of paper. This has become one of the major reasons for increased competition from imports.

For example, in FY1997-FY1998, Seshasayee Paper and Boards Ltd suffered from cheaper imports because of the removal of import duties on newsprint paper.

FY1998 annual report, page 4:

reduced import duties on paper from 65% to 20% in quick succession during first half of 1995…abolished import duty on newsprint in March 1994 and removed actual user condition for import of newsprint…paved the way for the import of good printing and writing paper in the garb of newsprint.

In the recent past, since 2014, Indian govt. reduced the duty on the import of paper from ASEAN countries to zero leading to an increase in the import of paper, which put significant pressure on companies like Seshasayee Paper and Boards Ltd in passing on costs to their customers.

Credit rating report by CARE, April 2018, page 2:

customs duty on paper in India has been brought down to zero; from 1st January 2014, as per the terms of the free trade agreement…Due to this, there has been a rise in paper imports from ASEAN countries…Thus, inability of SPBL to pass-on the high input prices may further put pressure on its operating margins.

In its FY2019 annual report, Seshasayee Paper and Boards Ltd highlighted the approach of the Indian govt. to reduce import duties on paper under trade agreements without putting in requisite safeguards as one of the key weaknesses in the industry.

FY2019 annual report, page 24:

Weaknesses in Industry: increasing imports consequent on numerous Regional Trade Agreements (RTAs) / Free Trade Agreements (FTAs) entered into by the Govt. without adequate safeguards

As a result, overseas players are able to price their products at 10% cheaper than what Seshasayee Paper and Boards Ltd sells in the Indian market.

Transcript of AGM, August 2020, page 15:

What is the gap in selling price between paper imports and sold by Seshasayee?

2.2.2) Small-sized inefficient-fragmented paper mills in India with inferior technology:

Indian paper industry is dominated by many small and medium-sized players who lack the benefits of economies of scale and therefore are not cost-competitive.

Credit rating report by CARE, April 2018, page 2:

Indian Paper industry has a fragmented structure consisting of small, medium and large paper mills, having capacities ranging from 5 to 1,150 tonnes per day

Historically, even the largest-sized paper mills in India have been medium-sized as per global standards. Seshasayee Paper and Boards Ltd highlighted it to its shareholders in FY2004.

FY2004 annual report, page 19:

Indian Paper Machines are mostly small in size. By global standards, even the largest machines are medium size, as large machines are today in the range of 4 00 000 – 6 00 000 tpa, with trim width upto 10 meters. Most Indian Paper Machines have a trim width of 1.5 – 3.5 meters only.

As a result, Seshasayee Paper and Boards Ltd acknowledged that to be competitive, it will have to grow in size. As a result, it started a mill development plan (MDP) in FY2005.

FY2005 annual report, page 9:

To be competitive and cost effective our Company’s present capacity of 115000 tonnes per annum is inadequate…profitable operations can be ensured only with enhancement of in-house pulping capacity and addition of new paper making capacity.

Seshasayee Paper and Boards Ltd also intimated to its shareholders in FY2006 that as per a consulting firm (Jaakko Poyry Consulting of Finland) appointed by the govt. lack of technology upgradation is the key reason for the non-competitiveness of Indian paper manufacturers.

FY2006 annual report, page 21:

The CPPRI commissioned Jaakko Poyry Consulting of Finland, in its report has clearly identified that lack of technology up-gradation is one of the main reasons for the Indian Paper Industry’s inability to be globally competitive.

However, even after more than a decade, as per Seshasayee Paper and Boards Ltd, the Indian paper industry still lacks global competitiveness.

FY2019 annual report, page 24:

Weaknesses in Industry: lack of global competitiveness in costs and quality

As per the company, one of the reasons for this lack of competitiveness is the inability of the Indian paper industry to merge into large players due to a lack of funds. In addition, most potential targets in India are small players with old paper mills, which can only produce inferior quality products.

FY2008 annual report, pages 25-26:

Though Indian Paper Industry is fragmented with numerous small players, warranting greater consolidation, the same is a distant possibility, except a few, due to the following factors:

there is shortfall in disposable funds available for investing in mergers and acquisitions.

The paper machines of small players are small in size and hence are not viable for acquisitions

The paper machines of small players are old, obsolete and would not interest foreign players. Such machines will produce only low quality products.

2.2.3) High cost of raw material in India:

In India, paper manufacturers are not allowed to access natural forests. In addition, paper manufacturers are not allowed to own land to grow trees as raw materials for their mills. Therefore, there is always an uncertainty about raw material availability.

In addition, when paper mills buy trees/wood from farmers, then it costs them almost twice what overseas paper manufacturers get in their countries. In India, Seshasayee Paper and Boards Ltd pays about $120 per tonne for wood, which is available to foreign players at about $60 per tonne.

As per the company, one of the main reasons for such an excessive cost of wood in India is the much lower size of plantation fields owned by farmers in India (2-3 acres) when compared to countries like Brazil or Indonesia (15,000 to 20,000 hectares).

Transcript of AGM, August 2020, pages 22-23:

in Brazil or in Indonesia, they grow tree in plantations of 15000 or 20000 hectares with modern technologies. Wood price is highly economical there…we take marginal farmers, having 2-3 acres of land…For example, we get wood at Rs 9000 per BD tonne (with Zero % moisture), roughly translating to US $ 120. Wood doesn’t cost more than US $ 60 in Indonesia.

As one tonne of paper needs 2 tonnes of wood; therefore, to produce 1 tonne of paper, companies need to spend $120 more in raw material costs in India.

Transcript of AGM, August 2020, page 23:

For one tonne of paper, we require two tonnes of wood. There is straight away US $ 120 difference in pulp cost between us and Indonesia.

The excessive cost of raw materials is not limited to wood. Even for recycled paper, the cost is higher in India because the collection of waste paper in India is low at about 30% than in foreign countries (60-70%).

Transcript of AGM, July 2021, page 22:

Collection of waste paper is poor in India. Our collection rate is less than 30% whereas internationally, it is about 60-70%.

While the high raw material cost is a weak point for Indian paper mills, the availability of cheaper raw materials is a key strength of European paper mills giving them a huge competitive advantage.

Transcript of AGM, July 2022, page 27:

European mills are very strong, they are extremely strong in raw material base in terms of soft wood. And they are significantly good in the recovery rates from waste paper, meaning waste paper recovery rates are very high in Europe. These are their strengths.

As a result of such competitive disadvantages of raw material costs, economies of scale and technological challenges, Indian paper mills are not able to compete with foreign players. High-cost structure of Indian paper mills makes their products uncompetitive in export markets.

As per Seshasayee Paper and Boards Ltd export of paper is less remunerative than sales in the domestic market. Only once in about four years, the export market provides better pricing than the Indian market.

Transcript of AGM, July 2022, page 31:

out of 4 years in a row probably you make more money in export only in one year. Other 3 years you get better realization in domestic market.

For example, in FY2010, Indian paper companies including Seshasayee Paper and Boards Ltd were forced to reduce their exports due to nonremunerative pricing.

FY2010 annual report, page 12:

domestic mills were also forced to cut-back on their exports, in view of un-remunerative prices prevailing in the overseas markets

Due to a lack of cost competitiveness, Seshasayee Paper and Boards Ltd realized that it would not be able to increase exports via its existing model to direct sales to foreign dealers/distributors etc. Therefore, in FY2012, it resorted to contract manufacturing for overseas paper manufacturers where it could get good volumes although at a lower profit.

FY2012 annual report, page 13:

Company had taken the initiative of stepping-up exports of the woodfree varieties and resorting to high volume ‘Contract Orders’ – albeit – at lower margins to combat the floundering domestic market.

Recommended reading: How to study Annual Report of a Company

In FY2020, Seshasayee Paper and Boards Ltd acknowledged that it is not very competitive than overseas paper manufacturers as they are more cost competitive and the company does not have any special advantage over them.

Transcript of AGM, August 2020, page 23:

The capacity that they have is far in excess of their requirements and therefore on marginal costing prices, they are able to dump paper everywhere at lower prices… We don’t have these advantages. Hence, we are not very competitive in our cost of manufacture. There is no distinct advantage.

As a result of such competitive disadvantages, Indian paper manufacturers find it difficult to compete with cheaper imports and in turn, lose their pricing power.

3) Attempts to become cost-competitive make paper manufacturing a highly capital-intensive business:

As discussed above, paper products are non-differentiable commodities and paper companies compete primarily on pricing to gain business from customers. As a result, being a low-cost producer of paper products is the biggest competitive advantage for paper companies.

In its AGM in 2020, Seshasayee Paper and Boards Ltd clearly highlighted to its investors that to succeed, the company must focus on its costs. It does not have any other special advantage over its competitors.

Transcript of AGM, August 2020, page 23:

we need to curtail the costs; we have to be competitive; we also need to see that there are not much leakages out of our system. We are not doing anything wonderful than any other big Paper Mill

To bring cost efficiencies, paper companies go for large plants to get economies of scale as well as higher bargaining power over their suppliers. As discussed previously, while going for its Mill Development Program (MDP) in FY2005, Seshasayee Paper and Boards Ltd acknowledged that to stay competitive and profitable, it would have to grow in size.

Moreover, to bring in cost efficiencies, paper companies have to go for integration of operations like having in-house pulping plants as well as captive power plants. These initiatives ensure that a paper mill can get its inputs at a lower cost than other mills that have to source pulp and power from the market.

For example, Seshasayee Paper and Boards Ltd bought a bankrupt paper mill Subburaj Papers Limited (SPL) in 2011, which struggled to function in the tough operating conditions and defaulted to its lenders. After the acquisition, Seshasayee Paper and Boards Ltd started supplying low-cost captive power and in-house pulp to SPL (later renamed Tirunelveli unit) and the acquired paper unit revived and started reporting profits.

Credit rating report by CARE, January 2017, page 1:

the loss making Tirunelveli unit performed well during H1FY17…With synergies derived from both the units by supply of pulp and power, the same led to improvement in the profitability margins.

However, all the steps of cost efficiencies mentioned above like large size leading to economies of scale and integrated operations with captive power plants make paper manufacturing a highly capital-intensive business.

Apart from the high initial capital required to install an integrated paper mill, companies need to continue to spend money to upgrade their technology to improve efficiencies and expand capacities to maintain market share.

As per Seshasayee Paper and Boards Ltd, in the last 5-7 years, the paper industry has invested more than ₹25,000 cr in newer technology plants.

Transcript of AGM, July 2022, page 9:

The industry has gone up the sustainability curve and has become far more technologically advanced. In the last five to seven years, an amount of over Rs 25,000 crores has been invested in new efficient capacities and induction of clean and green technologies.

Most importantly, companies have to keep spending money to meet ever-tightening environmental regulations. This is because first, the manufacturing of paper produces harmful chemicals and emissions. In addition, paper constitutes one of the biggest parts of daily waste production. As a result, environmental activists focus a lot on the activities of paper manufacturing companies.

Credit rating report by CARE, April 2023, page 3:

Paper manufacturing industry generates a notable amount of industrial air, water and land emissions as discarded paper and boards make up a large portion of landfills, which poses a threat to the environment.

FY2018 annual report, page 19:

Paper Industry is often at the receiving end from environmental activists who are wary of environmental footprint of this resources-intensive industry.

Due to often tightening environmental regulations, Seshasayee Paper and Boards Ltd had to spend a significant amount of money to comply with the updated requirements.

For example, in FY2004, the company had to invest significant funds to end the usage of chlorine in paper manufacturing.

FY2004 annual report, page 21:

Indian Paper Industry is expected to face environmental pressure for eliminating use of chlorine in bleaching. The investment required for this process change is substantial.

Similarly, in FY2006, the company had to completely change its pulping machines as they were very old and did not meet the guidelines under the “Charter on Corporate Responsibility for Environmental Protection (CREP)”.

FY2006 annual report, page 10:

existing Wood Pulping Equipment of the Mill is more than 30 years old and requires total replacement to sustain compliance under CREP and improve further.

Similarly, in 2012, the Indian govt. implemented the PAT (Perform, Achieve and Trade) Scheme and mandated guidelines for paper companies to use biofuel to produce energy for use in their plants.

FY2012 annual report, page 26:

With a view to curtail the carbon emission, Government of India, have introduced the PAT (Perform, Achieve and Trade) Scheme, calling for significant reduction in energy usage by the Pulp and Paper Units in a specified time frame. Further, REC (Renewable Energy Certificate) Scheme requires the Indian Paper Industry using a minimum percentage of bio-fuel in the fuel-mix

As a result, Seshasayee Paper and Boards Ltd had to make investments to enable its plants to use biofuels. By FY2015, it could significantly increase the usage of biofuels in its plants.

FY2015 annual report, page 59:

Unit: Erode: The Chemical Recovery Boiler with 16 MW Turbo Alternator is working on 100% Green Fuel

Unit: Tirunelveli: Use of Bio-fuel to the extent of 85% in the 6.5 MW Captive Power Plant.

Therefore, an investor would appreciate that to run cost-effective integrated paper production units, a company needs to spend a large amount of money initially and thereafter need to make significant investments to upgrade technology, meet environmental compliance norms etc.

However, these integrated paper mills are still price-takers with no bargaining power over customers; therefore, they earn a low return on their investment. Seshasayee Paper and Boards Ltd acknowledged this fact of poor returns on capital to its investors in FY2021.

FY2021 annual report, page 45:

Paper Industry is capital intensive and yields poor returns on investments.

Transcript of AGM, July 2022, page 29:

it is capital intensive industry, if you are getting a payback of say 4 years I think it is a good project, 5 years is also a good project.

Therefore, to reduce the funds required to expand and run paper manufacturing operations, Seshasayee Paper and Boards Ltd resorted to multiple measures like buying used/second-hand plants instead of installing brand-new machinery while expanding capacities.

In FY1998, when the company expanded its operations, then it bought a second-hand machine from Germany.

FY1998 annual report, page 6:

A good second hand Paper machine has already been imported from Germany for this Project

In FY2006, while implementing MDP-I, Seshasayee Paper and Boards Ltd imported second-hand machinery from the USA.

FY2006 annual report, pages 10-11:

The Project envisages replacement of the existing Pulp Mill for which the Company had entered into an agreement for procurement of a 350 tonnes per day used Pulp mill in USA

Recommended reading: When a company should sell all assets and invest money in FDs?

4) Paper industry’s business performance goes through boom and bust cycles:

A look at the profitability performance of Seshasayee Paper and Boards Ltd over the last 28 years (FY1996-FY2023), will show that it has faced alternate periods of improving and declining performance. NPM had routinely fluctuated between low levels of 1-2% and low double-digit levels.

One of the reasons for such fluctuating and cyclical performance is the linkage of paper demand with general economic growth. When general market sentiment is good, the demand for paper increases and vice versa. Therefore, when times are good, demand increases more than supply and then paper manufacturers announce capacity expansions.

However, a paper manufacturing unit requires a significant lead time for commissioning because it also requires environmental approvals (about 2-3 years). So, in total, a greenfield expansion may take about 4-5 years from planning to commissioning.

Transcript of AGM, August 2020, page 23:

Green field projects are very difficult because to get environmental clearance, it takes 2-3 years. Then you have another 30-36 months for execution.

As it takes a long time to complete new paper plants, most of the time, when the new capacities become functional the economic cycle has changed and demand is down. Then, the industry suffers from low demand and overproduction. It leads to the crashing of prices and profit margins.

For example, in the run-up to the global financial crisis, in FY2006-FY2007, when demand for paper and profit margins were increasing, many paper companies announced capacity expansions.

FY2007 annual report, page 22:

Over the next five years, incremental capacity addition is projected at around 2.6 million tonnes which is nearly 35% of current capacity of the industry…huge capacity additions, expected over the next few years, will exert pressure on domestic paper prices in the medium term.

When these capacities were completed over FY2008-FY2010, it led to oversupply and the net profit margins of Seshasayee Paper and Boards Ltd crashed from 11% in FY2011 to 2% in FY2013.

FY2014 annual report, page 41:

On the supply side, the industry saw significant capacity additions of 1.6 million tonnes during the Financial Year 2009 to Financial Year 2011…The bunching of these capacities resulted in over-supply scenario…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 Financial Year 2012.

As a result of oversupply and the resultant price crash, businesses suffer significantly. Seshasayee Paper and Boards Ltd has barely escaped from losses during such downturns when it reported low NPMs of 1-3% in FY1998-FY2002, FY2005, FY2009, FY2013-FY2015.

However, many players are not able to avoid losses in downturns, and as a result, shut down their production plants.

In FY1997, Seshasayee Paper and Boards Ltd had to postpone its expansion plan because the downturn made the project unviable.

FY1997 annual report, pages 6-7:

Company had drawn up an Expansion/Modernisation Plan costing over Rs 450 Crores, to double its installed capacity from 60 000 tonnes per annum to 1 20 000 tonnes per annum…The Project, as originally envisaged, has become unviable in the prevailing market conditions.

In FY2002, many paper manufacturing units shut down production to counter the downturn. However, it was still not able to balance the demand and supply in the market. Seshasayee Paper and Boards Ltd reported an NPM of 1% in FY2002.

FY2002 annual report, page 9:

Despite the production cut-back, announced by various paper mills abroad, there was an over-supply situation, due to decrease in demand. This had put pressure on the prices further.

The closure of mills during a downturn corrects the oversupply, which leads to demand becoming higher than supply. As a result, product prices increase and the surviving paper units generate good profits.

After the oversupply situation of FY2012-FY2015, many paper units shut down their production, which corrected the oversupply situation. As a result, the paper prices increased and in FY2017, Seshasayee Paper and Boards Ltd reported a healthy NPM of 12% up from 2% in FY2015.

FY2017 annual report, page 23:

Market conditions during the year 2016-17 were stable aided by a growing economy and restricted availability of paper in the domestic market on account of closure of some units.

The credit rating agency, CARE, has also highlighted the cyclical nature of the paper industry in its reports for Seshasayee Paper and Boards Ltd.

Credit rating report by CARE, April 2019, page 2:

The paper industry is inherently cyclical owing to the long gestation period in capacity addition and lead time for raw material generation

In FY2020 when Seshasayee Paper and Boards Ltd’s NPM had improved to 15% from a low of 2% in FY2015, the company acknowledged that the primary reason for such an improvement in performance is reduced supply due to the closure of paper mills.

FY2020 annual report, page 41:

Paper Companies posted a sharp turnaround in 2017-18 and 2018-19. Domestic paper demand remained buoyant as closure of stressed domestic capacities led to supply constraints.

In FY2023, when the company reported a lifetime high NPM of 19%, the credit rating agency, CARE, indicated that it is due to a sharp increase in demand for paper as the economy is opening up after Covid restriction.

Credit rating report by CARE, April 2023, page 1:

Post Covid, the pent-up demand for print & writing paper (P&W) increased sharply, mainly led by re-opening of schools, colleges, offices and institutions…Similar trend has been observed for the 9MFY23 period with full capacity utilisation and around 50% increase in realisations.

Advised reading: Credit Rating Reports: A Complete Guide for Stock Investors

Currently, the supply is low as many paper mills are not in operation. As has been in previous phases of upturns, soon we might witness an increase in supply from existing closed units as well as new capacities, which might lead to a correction of prices. Therefore, investors need to be cautious while projecting current profit margins in the future.

In fact, Seshasayee Paper and Boards Ltd has already disclosed plans for its capacity expansion (MDP-IV), which is typical behaviour in any cyclical industry where during an upturn, existing players announce capacity expansions.

The corporate announcement by the company to BSE dated April 29, 2023, page 1:

company to secure Environmental Clearances for project Mill Development Plan – IV (MDP – IV) in Company’s manufacturing facility in Erode, to augment Paper Capacity from 1,65,000 tonnes p.a. to 2,31,000 tonnes p.a.

An investor should always keep in the cyclical behaviour of the paper industry as evidenced in the historical performance of Seshasayee Paper and Boards Ltd over the last 28 years (FY1996-FY2023) while she projects its financial performance.

5) High dependence on the regulatory environment and govt. actions:

The business performance of Seshasayee Paper and Boards Ltd including all other paper players is affected significantly due to changes in policies by govt. especially related to taxes and levies like custom duties, and other indirect taxes as well as allocation of key resources like wood raw material and power.

In FY2001, when the company reported a net profit margin of 1%, then the main reason was the impact of additional excise duty of about ₹20 cr due to an increase in excise duty to 16%, which was announced in FY2000.

FY2000 annual report, page 9:

Government imposed a uniform rate of Excise Duty of 16% on paper manufactured both from conventional and unconventional raw materials…This measure is a serious blow…as the impact will be of the order of Rs.1000 lakhs for the existing production and another Rs 1000 lakhs for the production out of the new Paper Machine.

As a result, in FY2001, Seshasayee Paper and Boards Ltd had to pay an excise duty of ₹32 cr as compared to ₹13.5 cr in FY2000.

FY2001 annual report, page 5:

Excise Duty paid during the year was high at Rs 3238 lakhs, as compared to Rs 1348 lakhs, in the previous year.

A high outflow due to excise duty is detrimental to companies, which do not have pricing power because many times, they are not able to pass it on to customers and have to take a hit on their margins.

In FY2005, the company saw a decline in profit margins when the govt. withdrew the concessional excise duty rate of 12% from integrated paper mills using unconventional raw materials like bagasse etc.

FY2005 annual report, pages 17-18:

paper manufactured with not less than 75% unconventional raw material will be eligible for a concessional rate of excise duty of 12%, provided they are manufactured in the mills which do not have a plant attached thereto for making bamboo or wood pulp. By the above Notification dated 10 09 2004, large integrated paper mills, having facilities for making wood and bamboo pulp, have become ineligible

In FY2012, the profit margins of the company declined when the central govt. increased excise duty and the Tamil Nadu govt. increased value-added tax (VAT) on paper.

FY2012 annual report, page 27:

increase in rate of Excise Duty from 4% to 5% with effect from 1st March 2011 and 5% to 6% from 17th March 2012.

Tamilnadu Government increased the rate of VAT for Paper from 4% to 5%

Similar to the above case where adverse changes in the taxes hurt the performance of Seshasayee Paper and Boards Ltd, the performance of the company improved when govt. made favourable changes to taxation.

In FY2007, the NPM of the company improved to 10% from 5% in FY2006. The company stated that one of the reasons was the abolition of additional sales tax by the Tamil Nadu govt.

FY2007 annual report, pages 9-10:

Major factors that contributed to better profitability for the year: Abolition of Additional Sales Tax in Tamilnadu after introduction of Value Added Tax

In FY2008, when govt. reduced the excise duty on paper, then the performance of the company improved.

FY2008 annual report, page 14:

Increase in net sales realisation, due to increase in the prices of paper and reduction in Excise Duty on Paper from 12% to 8%

In FY2019, the company’s performance improved when govt. imposed an anti-dumping duty on the import of copier and Maplitho papers. As a result, competition from the import of these products declined.

FY2019 annual report, page 15:

Flow of imported Copier grades and Maplitho grades gradually moderated when the Customs Department imposed an Anti-dumping Duty on imported Copier

Apart from changes in duties and taxes, govt. influences the demand for paper products as a customer as well. For example, in FY2011, govt. placed large orders of paper products for census work and under the Right to Education Act., which led to a good performance of paper companies including Seshasayee Paper and Boards Ltd.

FY2011 annual report, pages 17-18:

census work, by Government of India, triggered demand for substantial volume of paper.

passage of the Fundamental Rights to Education Act in Parliament increased the demand for large volume of paper for text books and notebooks

However, in FY2013, the company’s business suffered when the Tamil Nadu govt. announced a free notebook distribution scheme.

FY2013 annual report, page 12:

Demand in the notebook segment had come down, due to announcement of free notebook distribution scheme by the Government of Tamil Nadu

Additionally, when govt. is not able to provide essential inputs like power to paper industries, then their performance suffers. For example, during FY2009-FY2010 and from FY2012 to FY2015, the profit margins of Seshasayee Paper and Boards Ltd suffered when the Tamil Nadu govt. put severe restrictions on the drawl of power from the grid.

FY2012 annual report, page 12:

The production could have been higher but for the severe restrictions on power availability imposed by the State Government, which affected production whenever our Captive Power Plants were shut for annual inspection and during maintenance related outages

FY2015 annual report, page 11:

Production was constrained due to restrictions imposed on Grid Power drawal by the State Government especially when Annual Shuts were taken upon our Power Plants.

Similarly, in FY1999, the project progress of Seshasayee Paper and Boards Ltd was impacted when the govt. changed its policies and mandated that the import of second-hand plants would require a license. As a result, the project completion of the company was delayed by about 7 months.

FY1999 annual report, page 7:

latest EXIM Policy announcement by the Central Government has come in the way, by putting restrictions on the import of second hand capital goods. After the said Policy announcement, import of second hand capital goods requires a licence.

The policy of govt. to restrict the access of paper companies for natural forest resources has led to a scarcity of raw materials for paper companies like Seshasayee Paper and Boards Ltd and has contributed to volatility in wood prices.

Credit rating report by CARE, April 2018, page 2:

The supply of wood to domestic paper industry from natural forest resources is restricted by strict government regulations and causing raw material availability issues.

Moreover, when Seshasayee Paper and Boards Ltd tried to enter into contracts with farmers for contract farming, then after putting in time and resources for about 5 years, it realized that it cannot enforce its contracts with farmers when they refused to sell the trees/wood to it despite agreeing to it in a written contract.

FY2011 annual report, page 19:

Many farmers, unmindful of the agreement, fell the trees and sell in the open market. They also do not settle the Bank dues. Consequently, the agreement is only on paper and the Company is not in a position to enforce the agreement terms with the farmers.

In addition to the above conditions where non-enforceability of contracts hurt the company, in FY2022, the company could not complete its project on time because govt. did not issue visas to Chinese nationals who could have installed the machinery on its site.

FY2022 annual report, page 41:

Chinese suppliers were not able to depute their engineers for installation jobs in India, since Indian embassy was not issuing visas to Chinese nationals.

Therefore, regulatory changes in taxes, duties, license/approval policies, and allocation of resources have a major impact on the performance of Seshasayee Paper and Boards Ltd and an investor should always keep it in her mind.

Recommended reading: How to analyse New Companies in Unknown Industries?

6) Dependence on nature for water and wood as raw material:

Paper production uses a lot of water and wood, which are natural raw materials and weather (e.g. monsoon) plays a significant role in their availability.

On numerous occasions, due to poor monsoon, the water level in the Cauvery river, which is its main water source, declined. As a result, Govt. put limits on its water consumption, which affected paper production by Seshasayee Paper and Boards Ltd.

FY2004 annual report, page 5:

production could have been higher by another 1000 tonnes, but for the water shortage and the poor quality of water from the River Cauvery

The company’s paper production suffered again in FY2017-FY2018 as well as FY2021 due to a water shortage arising because of poor monsoons.

FY2018 annual report, page 11:

Production was affected in both the Units due to severe shortage of water faced during the summer season due to continuous failure of monsoon

The company adapted to the scarcity of water by adjusting its process and product mix to reduce its consumption was water as well as resorting to alternate sources like groundwater.

Transcript of AGM, July 2021, page 18:

We were consuming 60 cu.metre of water per t of paper some time ago. Today we are consuming only 40 Cu.metre at Erode. Our consumption is hardly 12-13 cu.metres at our unit 2,

Just like water scarcity, excess rains also create issues for the paper industry because in heavy rains it becomes difficult to source wood and bagasse.

FY2005 annual report, page 15:

loss of production during October / November 2004, due to heavy rains in Tamilnadu that led to depleted inflow and non availability of raw material.

The paper industry has faced fluctuations in the prices of wood and bagasse as these are scarce resources and many competitors find uses for them.

FY2004 annual report, page 19:

scarcity of forest based raw materials resulted in scramble for acquisition of available material by competing mills, leading to raw material prices soaring to high levels in the last one year

Many sugar mills use bagasse as fuel in their captive power plants leaving little for paper manufacturers.

FY2004 annual report, page 21:

most of the sugar mills have their own co-generation power plants, based on bagasse, thus leaving a small volume of bagasse to the paper industry, as raw material for paper making.

In FY2013, the company faced challenges in sourcing raw materials and had to import costly pulp, which affected its profit margins, which declined to 2% during the year.

FY2013 annual report, page 24:

Prices of wood have shot up by well over 60% in less than a year’s time. Manufacturers are currently turning to overseas sources for meeting a part of their annual requirements, albeit, at higher prices.

7) Other cost reduction measures adopted by Seshasayee Paper and Boards Ltd:

We discussed above how Seshasayee Paper and Boards Ltd increased the size of its business to benefit from economies of scale, increased in-house pulping capacity and installed a captive power plant to reduce its operating costs to gain competitive advantages. Its Erode plant produces surplus pulp and power, which it transfers to the Tirunelvelii plant. Increasing pulp capacities have helped in significant improvement in profit margins as it replaced costly imported pulp.

Credit rating report by CARE, April 2023, page 2:

With excess production of pulp at the Erode plant, the company has also lowered the dependence on imported pulp to a certain extent as well, which in turn has also contributed to significant increase in the margins.

We also saw how the company relied on importing second-hand plants to lower the costs of its expansion projects.

Apart from the above, the company also took steps like a voluntary retirement scheme (VRS) in FY2006 after the company faced a cyclical downturn in FY2005 and its NPM had declined to 2%.

FY2006 annual report, page 12:

introduced two Voluntary Retirement Schemes, one with a benefit of lump sum payment and another Heirship Scheme. In total, 105 employees opted to retire under both the Schemes.

Maintaining a good relationship with labour is critical for paper mills including Seshasayee Paper and Boards Ltd because in the past, in FY2000, the company faced a strike by its labour for demanding a wage hike.

FY2000 annual report, page 11:

a flash strike resorted to by a section of workmen between August 31,1999 and September 4, 1999, to press their demand for increase in wages / salaries and other benefits

in FY2009, the labour could get bonus payments higher than the expectations of management impacting the profit margins of the company.

FY2009 annual report, page 33:

during the discussions held on June 14, 2008, an agreement was reached…providing more benefits than what were envisaged under the amended Payment of Bonus Act.

The credit rating agency, CARE has also highlighted the sensitivity of the paper industry to labour issues in its report for Seshasayee Paper and Boards Ltd in April 2023, page 3.

Paper manufacturing is labour-intensive; therefore, manufacturers are exposed to the risk of disruption from managing human capital efficiently, ensuring safety and overall well-being.

To ensure raw material availability, the company made significant changes in its input mix. Originally, it relied primarily on bagasse for paper production. However, in 1978, it started using primarily bamboo and in 1981, it started producing paper primarily from hardwood (Source: Company website).

Originally, designed for using bagasse, as the primary raw material mixed with 20% bamboo fibre. In 1978, Raw material mix underwent a substantial change, with bamboo and hardwood forming 60% and 40%. In 1981, it added one more digester, to increase the share of the hardwood in the furnish mix to 80% and restricting bamboo use to only 20%.

Later on, the company started focusing on bagasse and promoted its own sugar mill in 1984 to ensure an adequate supply of bagasse (Source: Company website).

In 1984, the Company promoted Ponni Sugars and Chemicals Limited, a sugar manufacturing unit as the captive source for bagasse supply.

Recently, the company after facing setbacks in getting farmers to grow trees under contract, has now shifted to a tree farming program where it supplies saplings and technical guidance to farmers and then buys trees from them at market price. Such steps have improved raw material availability for the company.

Transcript of AGM, August 2020, page 21:

We have created Ponni Sugars and the bagasse is available to us to cater to our bagasse needs. We have the tree farming programme, which helps us to grow as much wood as we consume. There is raw material security.

In addition, the company has a tie-up with sugarcane growers under its “Lift Irrigation Scheme” where it supplies treated water to the farmers for growing sugarcane who then sell the sugarcane to its associate company Ponni Sugars (Erode) Ltd.

FY2020 annual report, page 82:

Our Company has a structured, innovative Lift Irrigation Scheme by which our treated waste water is used to irrigate nearly 1500 acres of land in which local farmers grow sugar cane. The sugar cane produced is procured by our associate Company viz. Ponni Sugars(Erode) Limited which in turn gives bagasse

Further recommended reading: How to do Business Analysis of Sugar Companies

Over the last 10 years (FY2014-FY2023), except for FY2017 and FY2021, the tax payout ratio of Seshasayee Paper and Boards Ltd is in line with the corporate tax rate prevalent in India. The decline in the tax payout ratio in the recent year is due to a reduction in the corporate tax rate announced by India in FY2020.

In FY2017, the company reported a lower tax payout ratio of 23%, which is primarily due to the tax benefits available for captive power plants under IT section 80IA and for adjustment of carry-over losses. In the FY2018 annual report, an investor may check the previous year’s figures (FY2017) to understand the tax reconciliation numbers.

FY2018 annual report, page 191:

Tax on Deduction Under Section 80 IA -16.78 (₹ cr)

Carry Over Loss adjusted -16.19 (₹ cr)

FY2020 annual report, page 120:

Provision for Income-tax has been made considering the deduction under Section 80-IA in respect of the Captive Power Plant

Recommended reading: How to do Financial Analysis of a Company

Operating Efficiency Analysis of Seshasayee Paper and Boards Ltd:

a) Net fixed asset turnover (NFAT) of Seshasayee Paper and Boards Ltd:

Over the years, the NFAT of the company had stayed between 1 and 2, which represents a low asset turnover indicating the capital-intensive nature of paper manufacturing. NFAT declined to 1.1 in FY2021 because of reduced demand for paper production due to covid related lockdown.

In FY2023, NFAT has recovered sharply to 2.5 due to the opening of the economy post covid leading to pent-up demand for paper.

Going ahead, an investor should monitor the NFAT of Seshasayee Paper and Boards Ltd to understand whether it is able to efficiently utilize its assets.

Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors

b) Inventory turnover ratio (ITR) of Seshasayee Paper and Boards Ltd:

Over the years, the ITR of Seshasayee Paper and Boards Ltd has been within 7-9 levels. ITR declined to 3.9 in FY2021 due to covid lockdown as the company was not able to sell its inventory in the market. Post-pandemic, as the economy opened up, its ITR improved to 7.7 in FY2022 and 11.4 in FY2023.

Nevertheless, in FY2023, the company saw a sharp increase in inventory; however, as per the company, it was due to logistic challenges as at this time all companies faced challenges in getting containers for sea transport.

Transcript of AGM, July 2022, page 29:

Inventory increase in Q1, 3000 tons increased from March, this is only mostly logistic issues, almost all these are covered by orders…we have some difficulty in getting containers, we have some difficulty in getting shipping space

Frequently, Seshasayee Paper and Boards Ltd has reported zero finished goods inventory at the year-end.

Corporate announcement to BSE, April 1, 2023, page 1:

Company had sold its opening stock of finished goods as well as the entire quantity of paper produced during the FY 2022-23 and had achieved “Zero Stock of Finished Goods” at both of its units (Erode and Tirunelveli) as on March 31, 2023.

In the paper industry, manufacturers rely on the channel of dealers in addition to selling some quantity directly to corporate customers and govt. departments via tenders. These dealers in turn deal with actual consumers like small printing presses.

Rating Methodology for Paper Industry, ICRA, November 2015, page 2:

Paper is largely consumed by many small printers who work on behalf of various publishers/FMCG companies; hence most of the sales of the paper mills are typically through dealers/indentors who source orders from these printers and act as an interface between the mill and the customers.

Seshasayee Paper and Boards Ltd also sells its goods via dealers, distributors, indentors etc. both in Indian and foreign markets.

Credit rating report by CARE, April 2023, page 2:

It has a well-built network of more than 70 active indentors distributing SPB’s products across India and 10-11 international agents…Its production is largely order based procured by its dealer network.

As far as the claims of the company of achieving zero stock even during cyclical downturns, an investor may do her assessment whether the company had very good production management skills or it pushed goods to dealers to show zero stock like automobile industry where carmakers are said to push cars to dealers to show higher sales.

Dealer Group Accuses Maserati of Inflating Sales Numbers

Going ahead, an investor should check the inventory position of the company to assess whether it manages its inventory efficiently.

Further advised reading: Inventory Turnover Ratio: A Complete Guide

c) Analysis of receivables days of Seshasayee Paper and Boards Ltd:

Over the years, the receivables days of Seshasayee Paper and Boards Ltd have improved from 45 days in FY2015 to 17 days in FY2023. A reduction in receivables days shows that the company has collected its dues from customers in time.

Going ahead, an investor should watch the trend of receivables days of Seshasayee Paper and Boards Ltd to assess whether it continues to collect its receivables on time.

Further recommended reading: Receivable Days: A Complete Guide

When an investor compares the cumulative net profit after tax (cPAT) and cumulative cash flow from operations (cCFO) of Seshasayee Paper and Boards Ltd for FY2014-FY2023, then she notices that over the years (FY2014-FY2023), the company has converted its profit into cash flow from operations.

Over FY2014-23, Seshasayee Paper and Boards Ltd reported a total net profit after tax (cPAT) of ₹1,321 cr. During the same period, it reported cumulative cash flow from operations (cCFO) of ₹1,742 cr.

It is advised that investors should read the article on CFO calculation, which would help them understand the situations in which companies tend to have the CFO lower than their PAT. In addition, the investors would also understand the situations when the companies would have their CFO higher than PAT.

Further recommended reading: Understanding Cash Flow from Operations (CFO)

Learning from the article on CFO will show an investor that the cCFO of Seshasayee Paper and Boards Ltd is higher than the cPAT due to the following reasons:

  • Depreciation expense of ₹362 cr (a non-cash expense) over FY2014-FY2023, which is deducted while calculating PAT but is added back while calculating CFO.
  • Interest expense of ₹176 cr (a non-operating expense) over FY2014-FY2023, which is deducted while calculating PAT but is added back while calculating CFO.

Going ahead, an investor should keep a close watch on the working capital position of Seshasayee Paper and Boards Ltd.

The Margin of Safety in the Business of Seshasayee Paper and Boards Ltd:

a) Self-Sustainable Growth Rate (SSGR):

Read: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it can convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.

Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.

An investor may calculate the SSGR using the following formula:

SSGR = NFAT * NPM * (1-DPR) – Dep

Where,

  • SSGR = Self Sustainable Growth Rate in %
  • Dep = Depreciation rate as a % of net fixed assets
  • NFAT = Net fixed asset turnover (Sales/average net fixed assets over the year)
  • NPM = Net profit margin as % of sales
  • DPR = Dividend paid as % of net profit after tax

(For systematic algebraic calculation of SSGR formula: Click Here)

An investor would notice that over the years, Seshasayee Paper and Boards Ltd had reported an SSGR of 11-16% whereas over the last 10 years (FY2014-FY2022), it has grown its sales at a rate of 9% year on year.

As Seshasayee Paper and Boards Ltd has grown within the levels that can be supported by cash generated by its business operations, therefore, it has grown without raising debt or diluting equity. As a result, on March 31, 2023, the company reported a debt-free status.

For MDP-III, the company first requested a loan of ₹82.5 cr from lenders and availed disbursement of ₹11.2 cr. However, later the company decided that it could easily fund the project from its own cash generation. Therefore, it returned the loan of ₹11.2 cr taken and cancelled the balance loan.

Transcript of AGM, July 2022, page 17:

originally we availed around 11.2 crores out of the sanctioned 82.5 crores for the project MDP III. But then half way through, we decided that we will fund it with our own funds. Therefore, we have returned this 11.2 crores also.

Over the last 10 years, the company had the following changes in its equity capital. In FY2013, the share capital of the company increased as it issued shares to amalgamate its associate company Subburaj Papers Limited (SPL) with itself.

FY2013 annual report, page 51:

SPL shareholders are given 1363628 Equity Shares of ₹10/-each fully paid-up (pending allotment): ₹136 lakhs

In FY2020, it seems that the equity capital declined to ₹12 cr from ₹12.6 cr in FY2019. However, this change is due to the adoption of new Indian Accounting Standards (IndAS) where shares held by SPB Equity Shares Trust are deducted from equity capital.

FY2021 annual report, page 232:

Pursuant to the Scheme of Amalgamation of SPB Papers Limited with the Company, 568181 Equity Shares with face value of ₹10 each…were allotted to SPB Equity Shares Trust…in the financial year 2012-13. The original cost of the investment is adjusted in other equity

b) Free Cash Flow (FCF) Analysis of Seshasayee Paper and Boards Ltd:

While looking at the cash flow performance of Seshasayee Paper and Boards Ltd, an investor notices that during FY2014-FY2023, it generated cash flow from operations of ₹1,742 cr. During the same period, it did a capital expenditure of about ₹467 cr.

Therefore, during this period (FY2014-FY2023), Seshasayee Paper and Boards Ltd had a free cash flow (FCF) of ₹1,275 cr (=1,742 – 467).

In addition, during this period, the company had a non-operating income of ₹184 cr and an interest expense of ₹176 cr. As a result, the company had a free cash flow of ₹1,283 cr (= 1,275 + 184 – 176). Please note that the capitalized interest is already factored in as a part of the capex deducted earlier.

While looking at the overall cash-flow position of Seshasayee Paper and Boards Ltd over the last 10 years (FY2014-2023), an investor notices that the company has used its free cash flow primarily in the following avenues:

  • ₹389 cr as repayment of debt because over FY2014-FY2023, the company has repaid its entire debt of ₹389 cr outstanding in FY2014.
  • ₹163 cr as dividends excluding dividend distribution tax (DDT) to its shareholders. When DDT was applicable, then the company would have paid an additional 20% of the dividend amount as DDT.
  • ₹632 as an increase in the cash & equivalents from ₹62 cr in FY2014 to ₹694 cr in FY2023.

Going ahead, an investor should keep a close watch on the free cash flow generation by Seshasayee Paper and Boards Ltd to understand whether the company continues to generate surplus cash from its business and whether it continues to use it largely to pay dividends to the shareholders.

Further recommended reading: Free Cash Flow: A Complete Guide to Understanding FCF

Self-Sustainable Growth Rate (SSGR) and free cash flow (FCF) are the main pillars of assessing the margin of safety in the business model of any company.

Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

Additional aspects of Seshasayee Paper and Boards Ltd:

On analysing Seshasayee Paper and Boards Ltd and after reading annual reports, credit rating reports and other public documents, an investor comes across certain other aspects of the company, which are important for any investor to know while making an investment decision.

1) Management Succession of Seshasayee Paper and Boards Ltd:

Seshasayee Paper and Boards Ltd is the main company of the ESVIN group. Currently, promoters, Mr Sri N Gopalaratnam, Chairman, (age 76 years) and Mr K S Kasi Viswanathan, MD (age 72 years) are leading the company.

Both the promoters are very senior in age and as per the company, it is working on a success plan, which it may disclose in the coming year.

Transcript of AGM, July 2022, page 29:

Yes, sir, we have a succession plan and you will get to see them as we go by, in this coming year. We have seen a new induction into our board now; similar things will happen also probably next year or I think we have a succession plan in mind and we are implementing them in stages.

An investor should watch the developments at the company related to succession planning and contact the company directly for any clarifications.

It is essential that the new leadership team starts the transition when senior leaders are actively involved so that they can guide the younger people through the nuances of business decisions.

Further advised reading: How to do Management Analysis of Companies?

2) Probe by the Competition Commission of India (CCI) into unfair trade practices by Seshasayee Paper and Boards Ltd:

Currently, CCI is investigating the role of the company along with other large paper manufacturers in allegedly running a price cartel during January 2012-December 2013.

FY2021 annual report, page 94:

Allegation, leveled against large paper manufacturers in India (including our Company) of simultaneous price increases during the period January 2012 – December 2013, is currently under evaluation by the Competition Commission of India.

While CCI was investigating Seshasayee Paper and Boards Ltd, then it found an email sent by one employee of the company to its senior manager detailing meetings of smaller non-wood-based paper manufacturers for coordinated price actions. Based on those emails, CCI initiated an enquiry against non-wood-based paper manufacturers and found them guilty of running a price cartel.

As a result, the CCI put a penalty on some of the non-wood-based paper manufacturers and their industry association, the Indian Agro & Recycled Paper Mills Association (IARPMA), for their anti-competitive business practices.

CCI order, November 17, 2021, page 61:

Commission concludes that OPs had indulged in cartelisation in fixing prices of writing and printing paper as detailed in this order, by participating in the meetings convened under the umbrella of the platform provided by their trade association and discussing prices and the roadmap for coordinated increase, besides monitoring the decisions taken in such meetings.

CCI also found that due to cartelization, some of the players like Ruchira Papers Ltd increased their product prices even when their cost of production had declined.

CCI order, November 17, 2021, page 55:

The parallel behaviour of OP-12 by making an overall increase of Rs. 6000/- PMT between September 2012 to March 2013, coupled with an increase in prices despite fall in cost of production is strongly indicative of OP-12 being part of concerted conduct resorted to by non-wood based paper manufacturers, who increased prices after discussions in a coordinated manner.

In the CCI order, as per details on page 1, opposite party 12 (OP-12) refers to Ruchira Paper Ltd.

An investor may read our detailed analysis of Ruchira Papers Ltd along with the issue of warrants allotment by the company to its promoters where the promoters seem to have benefited at the cost of minority shareholders, in the following article: Analysis: Ruchira Papers Ltd

As per the CCI order, one of the paper manufacturers, Trident Ltd (opposite party 21) accepted its role in cartelization and price-fixing.

CCI order, November 17, 2021, page 58:

Yes, it is true that competing paper mills used to meet, discuss and arrive at a consensus on prices of paper to be increased and the quantum of discount to be offered.

Yes, on a few occasions we did implement the price increase decided in such meetings unaware of the consequences of this Act.

As discussed above, all the paper manufacturers are price-takers in the market as they produce nondifferentiable commodity products. Therefore, it seems that many paper companies joined together to decide the price in the market to gain pricing power.

The CCI enquiry against large paper manufacturers is still in progress. Therefore, investors should keep a close watch on the result of this enquiry and any order/penalty by CCI.

Further advised reading: How to Monitor Stocks in your Portfolio

3) Expansion projects by Seshasayee Paper and Boards Ltd:

As discussed above, paper companies do not have any pricing power over their customers and face intense price-based competition from both foreign and domestic paper manufacturers. In such a situation, low-cost producers of paper enjoy a competitive advantage.

Large paper producers enjoy a lower cost of production due to economies of scale. As a result, Seshasayee Paper and Boards Ltd acknowledged to its investors that for sustainable and profitable growth, it needs to increase its size.

Therefore, over the years, Seshasayee Paper and Boards Ltd has executed multiple expansion plans. Moreover, an investor also notices that the company kept on adjusting its expansion strategy to changing market situation.

For example, as discussed above, in FY1997, the company announced an expansion plan of ₹450 cr to increase its capacity from 60,000 MTPA to 120,000 MTPA. However, it shelved this plan when business conditions turned unfavourable (FY1997 annual report, pages 6-7).

Thereafter, during FY1998-2000, the company implemented a revised plan (₹188 cr) and expanded its paper manufacturing capacity to 115,000 MTPA (FY1998 annual report, page 6).

Thereafter, in FY2004, the company set up a 21 MW captive power plant for ₹65 cr. to reduce its energy costs and become a low-cost paper producer (FY2004 annual report, page 9).

Subsequently, in FY2006-2009, the company started a mill development plan (MDP-I) to replace its ageing pulp manufacturing equipment and chemical recovery boilers by spending about ₹350 cr (FY2006 annual report, pages 10-11).

In FY2015, the company started MDP-II for about ₹480 cr to increase its paper manufacturing capacity to 275,000 MTPA, pulping capacity to 145,000 MTPA and increase the capacity of the captive power plant by 15MW (FY2015 annual report, page 14). The plan was later downsized to a paper production capacity of 212,000 MTPA.

As soon as the MDP-II was completed in FY2019, immediately, Seshasayee Paper and Boards Ltd started its further expansion plan, MDP-III for about ₹315 cr (FY2019 annual report, page 17). Later, in the presentation for AGM in July 2022, the company intimated that it has reduced the cost of MDP-III to ₹288 cr and the project is nearing completion.

Presentation of AGM, July 2022, page 31:

MDP III: Revised Project Cost Estimate – Rs 288 crores…Project is nearing completion

After MDP-III, the company had a paper production capacity of 255,000 MTPA and pulping capacity of 154,000 MTPA (FY2022 annual report, page 37).

Now, immediately after the completion of MDP-III, Seshasayee Paper and Boards Ltd has started planning MDP-IV to increase its total paper production capacity to 321,000 MTPA (total for both units) and pulping capacity to 252,000 MTPA (both wood and bagasse). Phase-I of the plan will focus mainly on increasing the pulping capacity and will cost about ₹700 cr.

Corporate announcement to BSE dated April 29, 2023, pages 1-2:

Phase-I of MDP-IV will consist of activities for enhancing the pulp capacity to 2.52 lakh tonnes p.a. in Unit: Erode with a marginal increase in paper capacity…project cost for Phase-I is estimated at Rs.700 crores and the company expects to fund the entire project out of its internal accruals

An investor should closely watch the implementation of the expansion plans of Seshasayee Paper and Boards Ltd and assess whether it is able to complete them within time and cost estimates.

Like the acquisition of the stressed paper mill, Subburaj Papers Limited, done by the company in FY2011, currently, it is looking to buy another company, Servalakshmi Paper Mill Limited (SPML) via the route of bankruptcy law.

In FY2020, Seshasayee Paper and Boards Ltd expressed its interest in buying Servalakshmi Paper Mill Limited (SPML). However, soon Covid pandemic hit businesses. As a result, the company intimated to NCLAT that it would want to reduce the acquisition price.

Transcript of AGM, August 2020, pages 6 and 32:

during the FY 2019-20, the Company had submitted a composite scheme of compromise or arrangement with creditors and stakeholders of Servalakshmi Paper Mill Limited, under Liquidation.

Our company is approaching NCLAT for down revision of the scheme settlement terms, post Covid 19.

In FY2021, the company intimated to the liquidator that it is no longer interested in buying SPML.

It seems that after tough negotiations finally, it could get terms to its liking and now it has made a final offer to buy SPML. Nevertheless, its offer is challenged in front of NCLT who has reserved its decision in December 2022 and is yet to pronounce it.

Q4-FY2023 result document, April 29, 2023, page 11:

The Company participated and emerged as the successful bidder…for the Sale of M/s. Servalakshmi Paper Limited…Applications filed challenging the e-auction…were heard by NCLT, Chennai bench and the Hon’ble Tribunal had reserved the matters for Orders on 19.12.2022.

Investors should watch developments related to this acquisition to assess whether Seshasayee Paper and Boards Ltd has made a fair bid and if successful, then if it can revive this bankrupt paper mill.

4) Interconnected holdings of promoters in different companies:

An investor may notice a pattern in the way ESVIN group holds its stake in group companies. The group has made many companies hold shares of each other. Let us see some examples.

– Seshasayee Paper and Boards Ltd holds 27.45% of shares of Ponni Sugars (Erode) Limited and in return, Ponni Sugars (Erode) Limited holds 14.02% shares of Seshasayee Paper and Boards Ltd.

– Seshasayee Paper and Boards Ltd holds a 15.78% stake in High Energy Batteries (India) Limited (HEB) and in return, HEB holds a 0.08% stake in Seshasayee Paper and Boards Ltd.

– Seshasayee Paper and Boards Ltd held a 22.22% stake in SPB Projects and Consultancy Limited (SPB-PC) as per FY2002 annual report, page 57. As per FY2022 annual report, page 236, it has maintained its equity investment in SPB-PC. In return, SPB Projects and Consultancy Limited holds a 0.02% stake in Seshasayee Paper and Boards Ltd.

We as investors do not appreciate such interlinked shareholding patterns when promoters make a publicly listed company to buy shares of/give loans to their group companies and in return use that money (money is fungible) to buy shares of a public-listed company. It leads to an increase in the shareholding of promoters in the publicly listed company but it uses the money that originally belonged to all the shareholders i.e. including minority shareholders as well.

Let’s see how such transactions work by taking an illustration of a public company (A) and a promoter group company (B). The key steps involved in such transactions are:

  • Move the money of the company (A) to another entity (B). This entity (B) may be a subsidiary of the company or a promoter group entity.
  • The money may be transferred from A to B by way of either investment in the shares of B or as a loan or an advance to B.
  • Once the entity (B) has received the money, then it buys shares of the company (A) from the open market or from other large shareholders.
  • Thereafter, the promoters include the shares of the company (A) owned by the entity (B) in the promoters’ category and show a higher promoters’ shareholding in the company (A)

Such transactions result in promoters showing a higher shareholding in the company (A) to the stock exchanges. However, an investor would notice that the money used by the promoters to increase their stake is provided by the company (A). This money belonged to all the shareholders of the company, both promoters and public shareholders in their proportionate shareholding of the company (A). However, now the promoters end up taking benefit of all the shares of the company (A) bought by this money via the entity (B).

In addition, investors will find that the money given by company (A) to the entity (B) stays with B for long. If the money is by way of investment in the equity shares of B, then there is no need for B to return it ever. Even though, if the money given by company (A) to entity (B) is by way of loans or advances, then promoters as controllers of company (A) do not ask for repayment of the loan from B. In some cases, promoters as controllers of the company (A), make A give new money to B so that it can repay the old loans and continue to keep the money in one form or another (ever-greening).

We have analysed many companies that indulge in such interlinked cross holdings in group entities like Escorts Ltd, Ion Exchange (India) Ltd, National Peroxide Ltd (Wadia Group), Dynemic Products Ltd etc.

We have illustrated more such ways by which promoters increase their shareholding in listed companies in the following article: How Promoters use Loopholes to Inflate their Shareholding

5) Capital allocation decisions and investments in promoter-group entities by Seshasayee Paper and Boards Ltd:

Over the years, the company has invested in many companies, which belong to its promoter group, ESVIN group. It has invested money as equity as well as provided loans/intercorporate deposits (ICDs). At times, it even wrote off the money given to promoter group entities.

In FY2017, Seshasayee Paper and Boards Ltd wrote off intercorporate deposits (ICDs) of ₹5 cr effectively acknowledging that it gave ₹5 cr to someone from whom, now, there is no chance of getting it back.

FY2017 annual report, page 143:

Seshasayee Paper And Boards Ltd 5 Cr Of Loans Written Off

In FY2000, Seshasayee Paper and Boards Ltd wrote off its total investment of about ₹1.1 cr in Esvin Advanced Technologies Limited/

FY2000 annual report, page 36:

Miscellaneous Expenses under Schedule ‘Q’ includes write off of trade advances of Rs. 70.60 lakhs due from Esvin Advanced Technologies Limited and Rs 40.59 lakhs towards diminution in the value of investment in the equity shares of the said company.

Seshasayee Paper and Boards Ltd invested ₹12 lac in ESVIN Biosys International Limited in FY1998 as per FY1998 annual report, page 19. After 7 years, in FY2005, it wrote off its entire investment in ESVIN Biosys International Limited (FY2005 annual report, page 68).

Recommended reading: How Promoters benefit themselves using Related Party Transactions

Let us see some other capital decisions of Seshasayee Paper and Boards Ltd.

5.1) Esvi International (Engineers & Exporters) Limited:

In FY2013, Seshasayee Paper and Boards Ltd acquired shares of Esvi International (Engineers & Exporters) Limited (EIEEL) from promoters of ESVIN group i.e. it acquired a promoter-group company.

The company paid ₹12 cr to promoters for this acquisition.

FY2013 annual report, page 32:

ESVIN is a company belonging to the Promoter Group…Currently, it holds properties and derives property income. During the year, our Company acquired 100% of the shares of ESVIN at a consideration of ₹12 crores

Therefore, effectively, via this transaction, for ₹12 cr, Seshasayee Paper and Boards Ltd bought some properties belonging to the promoters.

As per the comparison of the standalone and consolidated balance sheet disclosed by the company in the FY2013 annual report, page 116, the incremental fixed assets in consolidated financials were only ₹1.45 cr (consolidated fixed assets: ₹ 716.28 cr, standalone fixed assets: ₹ 714.83 cr).

Therefore, effectively, Seshasayee Paper and Boards Ltd purchased assets with a value of ₹1.45 cr on the balance sheet for about ₹12 cr. Moreover, it was without considering the liabilities of EIEEL.

In FY2016 annual report, Seshasayee Paper and Boards Ltd disclosed some financial numbers of EIEEL. As per these financial details, EIEEL had a net worth of only about ₹18 lac because assets of ₹1.45 cr also had liabilities of ₹1.29 cr.

FY2016 annual report, page 69:

Seshasayee Paper And Boards Ltd Net Worth Of Subsidiary ESVI International Engineers And Exporters Limited

Moreover, in FY2017, Seshasayee Paper and Boards Ltd invested a further ₹2 cr in EIEEL (FY2017 annual report, page 106) taking the total investment to ₹14 cr.

As per the FY2021 annual report, page 268, EIEEL made a loss of ₹3 lac during the year.

An investor may contact the company directly to understand more about the properties owned by EIEEL to understand whether the original payment of ₹12 cr in FY2013 and the additional ₹2 cr investment in FY2017 made by Seshasayee Paper and Boards Ltd is reasonable. In addition, she may also seek clarification on whether there are any other assets/rights owned by EIEEL, which are not visible on the balance sheet that may influence the value of the company.

5.2) Ponni Sugars and Chemicals Limited:

The company promoted Ponni Sugars in 1984 as a part of the promoter group to get an assured supply of bagasse. Ponni Sugars had two units, one in Erode (TN) and another in Balangir (Orissa).

In FY1998, the financial condition of Ponni Sugars deteriorated significantly and it had to undergo financial restructuring where Seshasayee Paper and Boards Ltd had to invest an additional amount of ₹5 cr in Ponni Sugars in an attempt to revive it (FY1998 annual report, page 4).

However, despite additional investment, the company’s financial position did not improve and it underwent corporate debt restructuring (CDR) where its two sugar units were separated into Ponni Sugars (Erode) Limited and Ponni Sugars (Orissa) Limited.

In FY2003, Seshasayee Paper and Boards Ltd had to write off the Orissa unit when after remaining defunct for many years, the company could not sell it. In total, the company recognised a loss of about ₹7.5 cr on it.

FY2003 annual report, page 29:

The Balangir Unit of POL remains idle for the past couple of years. The revival of the unit seems to be impossible. Even efforts to sell off the units did hot fructify…The net worth of POL has been fully eroded…Consequently, our Company has written off the value of investments…The write off, so made, amounted to Rs 641 lakhs. Further, the lease rental arrears for the Boiler given on lease, amounting to Rs 120 lakhs…have also been written off as Bad Debts

In the AGM in August 2020, Seshasayee Paper and Boards Ltd acknowledged that an investment in the Orissa unit was a mistake.

Transcript of AGM, August 2020, page 24:

Ponni Sugars (Orissa) Limited went in to Liquidation and we have demerged from it…Unfortunately, Orissa venture was a misadventure.

Nevertheless, the Erode unit of Ponni Sugars seems to be working fine, even though the company had to invest more money into the equity capital of the unit during FY2011, FY2014, and FY2016. On March 31, 2022, the company invested about ₹20 cr in the equity capital of Ponni Sugars (Erode) Limited.

Ponni Sugars (Erode) Limited is a listed entity and as per its reported financials, it is a profitable and debt-free company.

5.3) Other investments:

In FY2003, Seshasayee Paper and Boards Ltd wrote off its investment in Seshasayee Paper and Boards Employees Co-operative Thrift and Credit Society Limited (FY2003 annual report, page 47).

In FY2003, the company invested in OPG Energy Private Limited. This investment was visible in the annual reports until FY2017 (page 142). However, after FY2017, the investment vanished from the annual reports. In the FY2018 annual report, there is no mention of this investment being sold.

In FY2015, Seshasayee Paper and Boards Ltd invested in shares of Bhatia Coke & Energy Limited. However, in the very next year, in FY2016, it sold this entire investment.

An investor may seek clarification from the company about the purpose of these investments and how they help public shareholders of the company.

Recommended reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

6) Foreign exchange fluctuations (forex) risk faced by Seshasayee Paper and Boards Ltd:

Seshasayee Paper and Boards Ltd faces forex risk primarily due to three factors.

First, it imports its entire requirement of coal for generating power in its captive power plant.

Transcript of AGM, July 2022, page 31:

20-25 years we have been importing coal; 100% of our coal from Indonesia, but then the last year or so the prices have shot up 3 times.

The company has to import its entire coal requirement because it neither has a linkage with any domestic coal mine nor has logistics infrastructure like a railway siding.

Transcript of AGM, July 2022, page 31:

Well, we are far away from mines and we don’t have a linkage with any mine, and we also don’t have linkage for railways.

As a result, whenever Indian Rupee weakens against foreign currencies, the cost of imported coal for Seshasayee Paper and Boards Ltd increases.

Second, the company imports a part of the pulp used at its Tirunelveli unit. Excess pulping capacity at Erode unit can take care of about 60% of the pulp requirements of the Tirunelveli unit.

Credit rating report by CARE, April 2020, page 2:

The excess pulp production at the Erode unit caters to around 60% of the pulp requirement of the Tirunelvelii plant

For the balance, the company has to buy pulp from domestic as well as overseas suppliers. Therefore, whenever, Indian Rupee weakens against foreign currencies, the cost of imported pulp for the company goes up.

For example, in FY2009, when Indian Rupee declined sharply against US Dollar, then the cost of imported pulp for the company increased sharply leading to a significant fall in its NPM to 3% from 10% in FY2008.

FY2009 annual report, page 16:

Major factors that contributed to lower profitability for the year: Adverse exchange rate between Indian Rupee and US Dollar resulting in higher cost of imported Pulp, imported Coal

Third, Seshasayee Paper and Boards Ltd exports about 15-20% of its production. Whenever Indian Rupee strengthens against foreign currencies, then its products become expensive for overseas customers hurting its competitiveness.

The company faced such a situation in FY2007 and FY2008 when Indian Rupee appreciated sharply against US Dollar and its exports became non-remunerative. Therefore, it had to cut down its exports.

FY2007 annual report, page 11:

Company scaled down its exports, since exports were becoming un-remunerative due to steep appreciation of Indian Rupee vis-à-vis US Dollar.

Going ahead, an investor should watch if the company enters effective hedging strategies to reduce the impact of foreign exchange fluctuations on its performance.

7) Scope for improvement in financial data presentation by Seshasayee Paper and Boards Ltd in annual reports:

While reading annual reports of the company from FY1997 to FY2022, an investor notices a few occasions, where she finds scope for improvement.

In FY2011, when Seshasayee Paper and Boards Ltd purchased Subburaj Papers Limited (SPL), then it gave a loan of ₹180 cr to SPL so that it could settle dues to lenders. These intercorporate loans and advances are usually shown by companies under cash flow from investing (CFI) whereas Seshasayee Paper and Boards Ltd classified it under cash flow from financing (CFF).

FY2011 annual report, page 80:

Seshasayee Paper And Boards Ltd ICD Shown Under CFF

Similarly, in FY2014 annual report, in the related parties’ section, Seshasayee Paper and Boards Ltd did not disclose numerous promoter-group entities with whom it does transactions on a day-to-day basis like Ponni Sugars (Erode) Limited, SPB Projects and Consultancy Limited etc.

FY2014 annual report, page 86:

Seshasayee Paper And Boards Ltd List Of Related Parties FY2014

In FY2015, the company updated its list of related parties and included many promoter-group entities.

FY2015 annual report, page 95:

Seshasayee Paper And Boards Ltd List Of Related Parties FY2015

An investor may note that all these promoter-group companies used to be a part of the list of related parties in earlier annual reports as well e.g. FY2013 annual report, page 68.

An investor may contact the company directly to understand the reasons why it removed promoter-group entities from the related parties’ list in FY2014.

Recommended reading: How to study Annual Report of a Company

The Margin of Safety in the market price of Seshasayee Paper and Boards Ltd:

Currently (May 11, 2023), Seshasayee Paper and Boards Ltd is available at a price-to-earnings (PE) ratio of about 4.6 based on consolidated earnings FY2023. An investor would appreciate that a PE ratio of 4.6 appears low and seems to offer a margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor. However, due to the recent sharp increase in profitability of the company due to upcycle phase, the PE ratio may seem lower.

Moreover, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, which considers the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.

In the absence of any strength in the business model of the company, even a low PE ratio of the company’s stock may be a sign of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.

Analysis Summary

Seshasayee Paper and Boards Ltd has grown its business at a rate of 9% per annum over the last 10 years (FY2014-FY2023). During this period, its profitability has improved significantly. However, a look at the profit margins of the company over the last 28 years (FY1996-FY2023), shows that the company’s performance follows strong cyclicity where profit margins have peaked at 11-15% and then declined to 1-2%.

Seshasayee Paper and Boards Ltd faces intense price-based competition because its products are non-differentiable commodities and customers can easily switch from one supplier to another. As a result, it faces strong competition from both domestic as well as international paper manufacturers.

Overseas paper players are attracted to the Indian market because it shows a strong growth potential whereas paper consumption in developed markets is slowing down. Moreover, the Indian govt. has reduced import duties on paper due to many trade agreements making imports more cost competitive.

Overseas paper manufacturers usually have large and efficient mills when compared to Indian paper manufacturers who have small-sized mills low on technology, which have a high operating cost. As a result, Indian players including Seshasayee Paper and Boards Ltd find it difficult to beat imports. The price of paper products of Seshasayee Paper and Boards Ltd is about 10% higher than the price of imported paper products.

Indian paper mills are also affected by high raw material/wood costs, which puts them at a disadvantage.

To become cost-competitive, paper mills like Seshasayee Paper and Boards Ltd need to grow in size to benefit from economies of scale and higher bargaining power over suppliers. In addition, they need to have integrated operations with pulping units and captive power plants. All these make cost-efficient paper units a capital-intensive business. Over the years, Seshasayee Paper and Boards Ltd has spent a significant amount of money in growing its production capacity, pulping capacity and on captive power plants.

Additionally, Seshasayee Paper and Boards Ltd had to spend a lot of money on replacing old equipment to meet changing environmental guidelines. Its performance is highly dependent on regulatory changes like excise tax, customs duties on imports, anti-dumping duties etc.

In addition, its business depends heavily on the availability of water, and wood, which are natural resources and the availability of power from the grid where govt. has significant control.

From its end, Seshasayee Paper and Boards Ltd has attempted a lot to reduce its costs like offering VRS to excess staff, buying second-hand equipment for expansion plans, promoting tree-farming to become wood-positive, tying up with farmers through the Lift Irrigation Scheme to promote sugarcane crop to source bagasse etc. However, despite all these measures, during downturns, it has barely avoided losses with NPM falling to 1%.

As paper manufacturers do not have pricing power over their customers; therefore, some players seem to have formed a cartel to control prices. As a result, CCI is conducting an enquiry into the role played by Seshasayee Paper and Boards Ltd in cartelization.

Over the years, the company has generated sufficient free cash flow so that it is now a debt-free company and has plans to fund its upcoming capital expenditure plans from internal cash accruals.

Promoters leading the company are now very senior in age and the company seems to be working on a succession plan, which it has promised to declare soon.

The promoters have formed inter-linked shareholding where most of the group companies hold shares of each other. We believe that such shareholding patterns are not in the best interests of minority shareholders and promoters should opt for simplified shareholding structures.

In the past, Seshasayee Paper and Boards Ltd has made many investments in promoter group companies where at times, it has given the money and later on written it off. Investors should be cautious while analysing such investments of the company in promoter-group entities.

Seshasayee Paper and Boards Ltd faces forex risk due to the import of raw materials like pulp and coal and also because it exports about 15-20% of its products.

In addition, while reading the annual reports of the company, an investor should be careful because there have been instances where it removed the names of many promoter-group entities from the list of related parties.

Going ahead, an investor should keep a close watch on the cyclical changes in the business performance of Seshasayee Paper and Boards Ltd and not get overly influenced by current significant improvement, which might be an upturn phase of a cycle. In the past, after significant improvement, its performance had declined sharply. An investor should always keep this in mind.

The investor should also keep a close watch on the policy changes affecting paper manufacturers, its inventory and receivables levels. She should track the progress of the proposed acquisition by the company and its upcoming MDP-IV project to see if it is able to complete it within time and cost estimates.

The investor should also watch its succession planning, the status of the CCI investigation, any additional investment by the company in promoter-group entities as well as its hedging steps to reduce the impact of forex changes.

Further recommended reading: How to Monitor Stocks in your Portfolio

These are our views on Seshasayee Paper and Boards Ltd. However, investors should do their own analysis before making any investment-related decisions about the company.

You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks

I hope it helps!

Regards,

Dr Vijay Malik

P.S.

Disclaimer

Registration status with SEBI:

I am registered with SEBI as a research analyst.

Details of financial interest in the Subject Company:

I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.

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