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Lord of low cost, master in a downturn
Brownfield expansion to steer volume growth
Orient Paper & Industries Limited (OPI) has increased its cement
capacity from 3.4mn tonnes at the end of FY09 to 5mn tonnes at the
end of FY10. On account of capacity additions, OPI has been growing
7.5x faster than the industry. Till August 2010, it has reported a
dispatch growth of 40% compared to 4.7% for the industry. On the
back of the strong volume growth, we expect EBITDA of the cement
division to grow YoY by 20% in FY11 despite low cement prices.
Low cost structure to guard earnings in downturn
OPI is the lowest cost producer (40% lower than industry average) of
cement in India due to its efficient plants and logistical advantages.
OPI is able to obtain all raw materials within a radius of 70 kms from its
plant. The average lead distance to market for OPI is only 350 km as
compared to 600 km for its peers. Furthermore, OPI is 100%
dependent (out of which 75% is linkage coal) on domestic coal, prices
of which are less volatile as compared to imported coal and petcoke.
Domestic coal (post adjusted for differences in calorific value of coal) is
cheaper than imported coal and petcoke by ~17% and ~13%
respectively. We believe that low cost structure will guard earnings of
the company in the downturn.
Investment accounts for 11% of market cap
OPI holds 1.55 mn shares of Century Textiles and 0.9 mn shares of
Hyderabad Industries. The market value of the company’s investment
is approximately INR1.4bn (i.e 11% of MCAP). Apart from this, OPI has
a paper plant at Brajrajnagar in Orissa where operations remain
suspended since 1999. OPI currently has around 850 acres of land in
this unit along with fully developed townships, educational institutions
and recreational centers.
Valuation
Despite having strong return ratios and margins, OPI is trading at a
steep discount to its frontline cement companies and the
replacement cost. At the CMP of INR 61 per share, the stock is
trading at 6x and 5.8x its FY11 and FY12 earnings, respectively. It is
trading at an implied EV/tonne of USD 50 and USD 40 its FY11 and
FY12 capacities, respectively. We are reiterating a BUY rating on the
stock with a revised priced target of INR 87/share. We have valued
the company on SOTP basis and the company’s paper and fan
division at EV/EBITDA multiple of 1.5X and 3x respectively. We
have valued the cement division at an EV/tonne of USD62/tonne
which we believe should be the fair value of the cement company
in the down cycle.
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