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Seshasayee Paper & Boards – A Solid Packaging Play : Stock Analysis December 2023

Disclaimer:
The analysis and opinions provided above are for educational and informational purposes only. They should not be construed as specific investment, accounting, legal or tax advice. Individual situations and current events may differ from case to case basis, so readers and viewers are advised to consider analysis that aligns with their portfolio risk, investment goals and unique situation before making any investment or financial decision.


Company Introduction: Seshasayee Paper & Boards (SPBL)

Seshasayee Paper & Boards (SPBL) is a 60-year old paper company focused on manufacturing printing, writing, and packaging grade paper. Headquartered in Chennai, it is the flagship company of the SPB-ESVIN group. Some key facts about the company:

Products & Brands

SPBL manufactures a variety of paper products including printing and writing grade paper, packaging grade paper, specialty paper etc. under leading brands like Sprint, Sprint Plus, Swift, and Success. These are among the top brands in South India.

Financials

SPBL has delivered strong growth over the last decade with sales and profits growing at 10% and 34% CAGR respectively. In the latest year FY22, it posted sales of ₹1,918 crore and net profit of ₹374 crore. Margins have also expanded significantly from 13% in FY13 to 26% in FY22. Return on capital employed stands at 37%.

Balance Sheet

The company has an extremely strong balance sheet with zero debt and cash/investments of over ₹1,150 crore as of Mar-23. Peak working capital requirement is just 14 days of sales highlighting excellent capital efficiency.

Should We Buy, Sell or Hold?

In my view, Seshasayee Paper makes for a compelling consideration for  BUY case currently for multiple reasons:

Strong volume growth outlook

Packaging boards are seeing strong demand growth led by ecommerce, FMCG, pharmaceuticals etc. Players like SPBL are expanding capacity to cater to this demand (it added capacity in 2020). We could see 12-15% volume growth ahead.

Margin expansion underway

SPBL’s margins at 26% give good headroom for further expansion as operating leverage kicks in. Management has guided for 30% margins ahead. Declining pulp prices are an added tailwind on profitability.

Excellent capital allocation

The debt-free balance sheet and rising cashflows give SPBL a lot of capital allocation optionality. $190 mn capex over next 3-4 years is planned to drive growth. High dividend payout leaves room for more shareholders returns.

Attractive valuations

The stock trades at reasonable 5.9x FY23 earnings. Valuations can re-rate significantly from a potential EPS of Rs 95-100 giving 25-30% upside. Privatisation of promoter holding also opens up possibility of offer for minority shareholders.

Overall, SPBL has all the hallmarks of a long-term compounding story – market leadership, growth runway, improving profitability, and strong balance sheet. At current valuations, the risk-reward is favorable for investors with 2-3 year horizon.

Vital Company Ratios

Some key ratios that capture the essence of Seshasayee Paper’s investment case:

Debt/Equity ratio

Debt/Equity ratio of 0.0x highlights fortress-like balance sheet – company has repaid all debt in the last few years.

Dividend Yield

Dividend Yield of 1.7% leaves potential for higher payouts given strong cashflows.

Sales and Profit CAGR

5-year Sales and Profit CAGR of 14% and 27% show acceleration. Even on trailing basis growth is around 60%.

Return on Capital Employed

Return on Capital Employed of 37% highlights the capital efficiency and profit potential of the paper packaging business.

Price to Book ratio

Price to Book ratio of just 1.2x indicates the stock is still reasonably valued despite the rally.

Promoter shareholding

Promoter shareholding is stable around 43% giving confidence on strategy execution.

Additionally, working capital metrics also showcase the operational excellence:

  • Debtor days have come down from 47 to 16 showing efficiency.
  • Inventory is at adequate levels to service demand.
  • Cash conversion cycle is just 21 days v/s industry at 60 days.

In summary, the vital signs for SPBL – growth, margins, ROCE, promoter holding, valuation, and working capital are all healthy or showing good momentum. This makes a strong case for considering buying the stock.

Seshasayee Paper & Boards - A Solid Packaging Play : Stock Analysis December 2023

Trend Analysis

Promoter Holding Stability

  • Promoter holding stable at ~43% over the last 5 years.

Institutional Investors

  • FII stake increased from 14% to 16%, while DII holdings remained stable around 30%.

Sales and Profit Growth

  • Sales have grown at a 14% CAGR over the last 5 years, with profits up by 27% CAGR.

Debt Reduction

  • Debt has reduced significantly from Rs. 124 crore in FY20 to zero in FY23.

Operating Margin Improvement

  • Operating margins have improved from 13% in FY13 to 26% in FY23.

Valuation

  • PE ratio is at 5.9x, compared to an industry average of 12.1x.

Intrinsic Value

  • Intrinsic value of Rs. 774, while the current market price is Rs. 352.

Market Capitalization

  • Market Cap stands at Rs. 2,221 crore, with a 5-year CAGR of 15%.

Industry Growth

  • The industry is experiencing growth with rising demand for paper packaging.

Latest News

  • Planning Rs. 1,400 crore expansion over the next 3-4 years.
  • Doubling packaging board capacity and adding new products.
  • Commissioned a new wind power plant with a focus on ESG initiatives.

Financials

  • Cash & investments of Rs. 1,154 crore as of March 2023.
  • Dividend payout has steadily risen from 25% to 57%.

Peer Comparison

Seshasayee Paper is a leading player in the paper industry, and some of its key listed peers are West Coast Paper, TN Newsprint, JK Paper, and Andhra Paper. When compared to these peers, Seshasayee Paper has demonstrated very strong performance across multiple parameters:

Profitability

  • SPBL’s operating margins at 26% outperform peers like JK Paper (18%), West Coast Paper (16%), and Andhra Paper (14%). This enables SPBL to convert growth into profits more effectively.

Capital Efficiency

  • SPBL’s return on capital employed (ROCE) at 37% surpasses its peers, showcasing prudent capital allocation. Only West Coast Paper comes somewhat closer with a 33% ROCE.

Working Capital

  • Excellent working capital management has allowed SPBL to operate with a negative cash conversion cycle and just 14 days of working capital requirement. In contrast, peers have a 30-90 days requirement, leading to higher financing needs.

Balance Sheet

  • SPBL’s zero debt and resulting financial leverage provide flexibility for funding growth, while most peers carry moderate debt levels.

Growth

  • While paper demand is expanding across the industry, SPBL has managed to grow faster by leveraging its competitive advantages, leading to rapid market share gains.

SPBL has consistently outperformed most of its peers in terms of profitability, return ratios, and growth, all while maintaining a conservative balance sheet. This superior performance is reflected in the higher valuation multiples that the stock commands.

Valuation View

I believe Seshasayee Paper is undervalued considering its growth prospects and strong competitive position:

  • The stock trades at a P/E multiple of 5.9x, nearly 50% lower than the industry average of 12x.
  • Moreover, the company has posted nearly 30% EPS growth in the last 3 years and is on track for 25-30% growth ahead.
  • SESHAPAPER’s return on equity is approximately 28%, which is twice that of industry peers.
  • The intrinsic value, as per my estimates, is at Rs 774 per share, providing more than 100% upside from the current market price of Rs 352.

Overall, while paper stocks typically trade at 12-15x PE multiples, SESHAPAPER deserves a much higher multiple of 18-20x on FY24 EPS of Rs 100. This suggests significant upside potential even after the recent run-up.

Should We Buy?

I believe investors can consider BUY the stock of Seshasayee Paper for the long term for the following reasons:

  • It is the fastest-growing paper company with leadership in the south Indian paper market.
  • Strong brands, extensive distribution, and quality products provide a competitive edge.
  • Capacity expansion and entry into new product lines will drive growth for the next 3-4 years.
  • Margins can expand from 26% to 30%+ as operating leverage kicks in.
  • A strong balance sheet allows it to tap organic and inorganic opportunities.
  • Undervalued even after the recent rally, with potential for re-rating as growth delivers.
  • Management has a good track record of capital allocation and minority shareholder interest.

Seshasayee offers a rare combination of growth, profitability, a strong balance sheet, and reasonable valuations. The risk-reward is quite favorable for long-term investors.

Industry Outlook

The Indian paper and paper products industry is expected to grow at a healthy CAGR of approximately 13% over the next five years. This growth will be driven by:

  • Expanding demand from end-user industries like ecommerce, FMCG, pharmaceuticals requiring packaging materials.
  • Import substitution as domestic players expand capacities.
  • Increasing use of paper packaging instead of single-use plastics.
  • Growth in print media, especially regional languages, driving demand.

Within the paper industry, the packaging boards segment where Seshasayee Paper operates is likely to outpace the overall industry growth. This is due to higher demand for eco-friendly packaging from consumer industries.

Additionally, large integrated paper companies will gain share from smaller players due to their economies of scale. This favors the competitive positioning of Seshasayee Paper.

Thus, the underlying industry dynamics remain very conducive for the company. Seshasayee can leverage this by delivering volume growth ahead of the industry along with margin expansion.

Long Term Outlook

I expect Seshasayee Paper to deliver a robust long-term outlook with an anticipated 18-20% revenue CAGR and 25-28% profit CAGR over the next 5 years. This growth will be driven by various factors:

Volume Growth Drivers

  • The company is set to expand its packaging boards capacity by 60%, equivalent to 1 lakh tonnes over the next 3-4 years, through a capital expenditure of Rs. 1,400 crores.
  • This expansion includes the establishment of a new facility in Tamil Nadu and debottlenecking of existing units.
  • The added capacities will target new product categories like coated duplex boards, food-grade boards, and more, in addition to traditional products.
  • The food-grade packaging segment is experiencing high growth due to the ban on single-use plastics and increased demand for eco-friendly packaging. The company has developed specialized products like oil & moisture barrier boards to tap into this demand.
  • High capacity utilization of existing capacities, around 85-90%, leaves room for volume expansion through debottlenecking and efficiency gains.

Margin Growth Drivers

  • Operating margins have already expanded from 13% in FY13 to 26% in FY22, primarily through raw material cost control and operating leverage.
  • Management has guided for best-in-class margins of 30%+ on the new capacities as the product mix shifts more towards value-added products.
  • This will lead to blended margins steadily expanding to 28-30% over the next 5 years.
  • The decline in key input costs like pulp and coal will also provide tailwinds to profitability.

Overall, with a volume CAGR of 15-18% and margin improvement from 26% to 30%, Seshasayee Paper is well-positioned to deliver strong earnings CAGR of 25-28% over the next 5 years.

Short Term Outlook

In the near term, Seshasayee Paper is poised to deliver strong growth in FY23 and FY24 driven by several factors:

  • Healthy demand momentum is expected to continue with 7-8% volume growth in the packaging boards segment.
  • The full impact of the 10% price hike taken in FY22-23 will reflect in the next 2 quarters, aiding realizations growth.
  • A dip in key input prices like pulp and coal is anticipated to boost margins by 250-300 bps in FY23.
  • New products like coated boards and barrier boards are gaining good traction with customers.

Earnings Growth Breakdown

FY23

  • Revenue growth of 28%, driven by volume growth of 10-12% and price hikes.
  • Margin improvement from 25.6% to 28%, with a 300 bps expansion.
  • Net profit growth of 40-45%.

FY24

  • Revenue growth of 22-25% on volume growth of 12-15% and improved realizations.
  • Margin improvement from 28% to 29%, adding 100 bps.
  • Net profit growth of 30-35%.

Thus, healthy volume-led growth coupled with margin drivers can boost EPS by 40% in FY23 itself. The strong momentum is expected to continue in FY24 as capacity enhancements start reflecting in volumes while margins expand further, positioning Seshasayee for very strong earnings growth over the next 24 months.

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