A paper trail to value? – Due Diligence on JK Paper (Part 1/2)
I have decided to divide this DD into two parts as it has a lot of content for the industry part. I will be posting the company’s detailed valuation assessment in the 2nd part soon. The link will be in the comments.
JK Paper Ltd. is a leading player in the Indian paper and packaging board industry, specializing in the manufacturing and distribution of a diverse range of paper and packaging products. With a rich history and a strong market presence, the company has demonstrated resilience and growth in a competitive industry.
However, it seems like investors have fallen out of favour with the company. In fact, if you look at the NIFTY 500 index, it has generated approx. 13% growth YTD compared to an approx. -10% decline for JK paper share price. On the surface, it might seem like a pretty mature market company in a mature market (paper and paper products) with little growth prospects. Or at least that’s what the market thinks!
# Paper and packaging industry
It is important for us to spend time on this section as in my opinion majority of retail investors tend to limit their analysis of any industry to the first order of thinking (here’s a (https://www.reddit.com/watch?v=x0APs1ObxF8&ab_channel=ValueInvestorsArchive) about second-order thinking)
In India, the paper and paper board packaging market stands at around USD 10-12 Bn or INR 83,00 -99,000 Crores. It is expected to grow at a CAGR of 6-7% till 2027 and reach a value of USD 15-16 Bn or INR 125,000 – 133,000 Crore. (the reason why I’ve provided a range is that there are multiple sources for this information – Company’s annual reports, competitor’s annual reports, independent research bodies, and trade groups)
The industry is quite fragmented with multiple SMEs and a few large players like JK paper and West coast paper mills (we shall discuss this further when I talk about my views on the company’s prospects)
It consists of 4 segments:
|**Packaging grade paper (incl. corrugated packaging)**|**Writing and printing** |**Newsprint** |**Specialty**|
The exports and imports for paper and packaging board (2021-22) are as follows.
Now here is a common misconception that investors have about this industry.
“Since offices are becoming increasingly digitised, the demand for paper should go down as there’s not much requirement for printing and writing paper”
1. I agree, the demand for paper needed for printing and writing has slowed down but it has not decreased.
2. It’s the slowest segment of the industry (expected growth of 1-2% over the next 5 years); rightfully so, there are not many growth prospects in this segment.
3. However, the overall share of printing and writing paper in the entire industry dwarfs in comparison to packaging grade paper (23% vs 70%) which is the leading driver for growth in the industry
Key demand drivers for the packaging grade paper and the overall industry
1. **Per capita consumption** – India has a considerably low paper and paperboard consumption per capita compared to other countries (**15 Kg vs a global average of 56 Kg**)
2. **Rise of consumer-packaged goods** – Significant growth in the FMCG, pharma, Food & beverages, and e-commerce (which in turn is driven by increasing urbanisation and disposable income) is expected to fuel the demand for packaging paper
1. FMCG – expected to grow at 15% annually to reach USD 220 Bn by 2025 (ICICI)
2. E-commerce – expected to grow at 16% annually from USD 83 in 2022 Bn to USD 150 Bn in 2026 (FIS Global payment report)
3. Pharma – expected to grow at 14.5% annually from USD 50 Bn in 2023 to USD 130 Bn in 2030 (IBEF)
4. Food and beverages packaging industry – expected to grow at 15% annually from USD 32 Bn in 2022 to reach USD 86 Bn in 2029 (All India Food Processors Association)
3. **Sustainability angle** – There has been increasing impetus laid on the sustainability of various businesses which are actively trying to reduce the use of plastic-based packaging and replacing it with eco-friendly alternatives such as paper
With all good things, there are some caveats to the industry as well
1. Fluctuations in pulp prices can impact production costs, affecting profit margins for paper and paperboard manufacturers
2. Competition driven by low-cost producers in other regions can pressure pricing and market share for companies in the industry
3. Increased use of digital alternatives for communication and documentation poses a threat to traditional writing and printing paper
4. High energy consumption in paper manufacturing contributes to increased operation costs
# Closing thoughts on the industry
As I said before, the industry remains fragmented to a large extent with multiple small, medium
, and large plants operating independently ranging in capacity from 5 to 2000 tonnes per day. This bears a very crucial implication for my outlook on the industry – once the organic growth of the industry slows down, we will observe rapid consolidation in years to come. In some sense, it has already started and major players such as JK Paper and West Coast are already picking up these fragmented players. This early initiative can be explained by two factors;
1. Capital intensive companies prefer to space out their CAPEX over several years to ensure there are no sudden shocks to their cashflows and by the time the growth slows down (5-6 years from now) they will already be in a much stronger position
2. Improving competitive advantage by increasing the cost of entry for newer players. It is primarily assessed from the asset requirements for the industries which are predominantly manufacturing and commodity based.
Eventually, we are likely to end up with an oligopoly of 3-4 major players capturing the major market share.
*Disclaimer: This is my first attempt at writing down my thoughts about an investment and by no means I am a financial advisor. Please feel free to share your feedback on how I can improve on this as I’m planning to do more of these posts.*
*I have a beneficial long position in the shares of JK paper*. *Do your own research and this post should not be considered as investment advice*