Ballarpur Industries - EBITDA margins disappoint: Emkay

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Ballarpur Industries

EBITDA margins disappoint

BUY

CMP: Rs 32                                       Target Price: Rs 42

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n     Q2FY11 results, though in line with estimates with APAT of Rs 480 mn (+5% yoy), disappointed with EBITDA margins at 19.3% (-330 bps yoy / -120 bps qoq), lowest since FY07

n     RGP segment benefited from strong demand, EBIT / mt increased up to Rs 13,200 / mt (FY10 average at Rs 6,500 / mt). Benefit to continue up till Q4FY11

n     BILT is increasing pulp capacity with capex of Rs 13 bn to reduce dependency on imported pulp. Completion should help in improving EBITDA margins by ~500 bps to 25%

n     Downgrade FY11 / FY12 estimates by 35% / 6.5% to Rs 3.4 / Rs 5.1 however maintain BUY recommendation on attractive valuations and triggers from listing of subsidiary

Higher paper and pulp prices drove revenues by 27%

BILT’s Q2FY11 revenues increased by 27% yoy to Rs 11.3 bn (marginally ahead of our

estimates of Rs 10.7 bn). Paper segment revenues increased by 28% yoy to Rs 10 bn

driven by volume growth of 9.7% (to 213,375 mt) and realisation growth of 16.5% yoy

(to Rs 46,256 / mt ). RGP (Rayon Grade Pulp) segment posted healthy growth of 32%

yoy to Rs 1.2 bn driven by higher realisations. Pulp realisations increased by 38% yoy to

Rs 51,718 / mt. Management expects pulp prices to go up further to Rs 60,000 / mt on

account of strong demand for RGP. However prices are likely to soften from H1FY12.

EBITDA margins at 19.3% were the biggest disappointment

EBITDA margin contraction of 330 bps yoy / 120 bps qoq to 19.3% was the biggest

disappointment during the quarter. Current EBITDA margins are at their lowest levels

since FY07 - due to change in cost structure. With pressure on EBITDA margins,

EBITDA increased merely by 8.5% yoy to Rs 2.2 bn (in line with our estimates of Rs 2.2

bn).

Softening pulp prices should drive margins going forward

With 44% increase in paper capacity to 970,000 mt in the previous two years without a

corresponding increase in pulp capacity, BILT’s dependency on imported pulp has

increased from 15% to 40%. With pulp prices ruling at higher levels (US$ 750 / mt in

Q2FY11increased by approximately 50% yoy) as against relatively stable paper prices,

conversion margins on paper have been under pressure. However pulp prices have

started softening recently and are expected to decline by ~15% to US$ 650 / mt by the

end of Q3FY11 which should help in margin expansion going forward. We expect the

company’s H2FY11 EBITDA margins to improve to 21.1% in H2FY11 as against 19.9%

in H1FY11.

APAT growth of 5.3%yoy, marginally below estimates

PBT for the quarter increased by 13% yoy to Rs 725 mn (in line with estimates) however

with higher than estimated tax and minority interest, APAT at Rs 480 mn, +5.3% yoy,

was marginally below estimates of Rs 528 mn. AEPS for the quarter stood at Rs 0.7.

Benefit of higher RGP prices to continue for the next two quarters

RGP (Rayon Grade Pulp) prices increased up to Rs 51,700 / mt by Q2FY11 and the

management indicated that prices are expected to increase further up to Rs 60,000 / mt due

to firm demand from VSF segment. RGP segment EBIT margins increased up to 26%

resulting in EBIT / mt of Rs 13,200 / mt which we estimate to strengthen further to Rs

15,000 / mt on account of higher realisations (effective for Q3FY11).

However we believe that current margins in RGP are likely to soften from Q1FY12 and

estimate margins to hover at around 20%.

Paper segment margins to improve on account of falling pulp prices

EBIT margins in paper and paper products declined to 11% in Q2FY11 indicating EBIT / mt

at mere Rs 5,000 / mt as against Rs 6,000 / mt in Q2FY10 and average of Rs 8,000 / mt in

FY08. Paper margins have been under pressure due to rising pulp prices. Prices for pulp

increased by approximately 50% to US$ by 750 / mt in Q2FY11. However pulp prices have

started softening and are expected to decline by 15% to US$ 650 mt in Q3FY11. This

should result in paper segment margins improving from 11% in Q2FY11 to 12.4% by

Q3FY11 and further to 14.1% by Q4FY11

Expect EBITDA margin expansion of 130 bps in H2FY11

With RGP prices remaining strong and falling pulp prices driving paper segment margins,

we expect, BILT should see overall EBITDA margin expansion of 120 bps to 21.1% in

H2FY11 as against 19.9% in H1FY11.

Stand alone results remain under pressure

BILT on stand alone basis reported revenue growth of 12% yoy to Rs 2.8 bn while EBITDA

margins fell sharply by 590 bps yoy / 100 bps qoq to 16%. Resulting EBITDA declined by

18% yoy to Rs 442 mn. EBITDA margin pressure is mainly due to company’s increased

dependency on imported pulp, since BILT on stand alone basis meets approx 50% of its

total pulp requirement through imported pulp. We expect with pulp prices softening, BILT’s

stand alone margins should also improve going forward.

At PBT level, the company reported fall of 37% yoy to Rs 149 mn and APAT for the quarter

stood at Rs 91 mn, -44% yoy.

Company’s capex plan to increase pulp capacity – on schedule

To reduce its dependency on imported pulp, BILT has chalked down aggressive capex

plans with estimated cost of Rs 13 bn to add pulp capacity of 290,000 mt. These capex

plans include –

¾ Pulp expansion at SFI expected to add Rs 1.5 bn to EBITDA

The company is increasing pulp capacity at SFI (Malaysia) plant by 120,000 mt with

estimated cost of Rs 8 bn (US$ 180 mn). This capex is likely to be completed by

Q1FY12 and should help the company to reduce its dependency on imported pulp. BILT

has already invested Rs 4.5 bn (US$ 110 mn) while balance is likely to be met through

internal accruals. We expect this will help the company to achieve incremental EBITDA

of Rs 1.5 bn and should help in EBITDA margin expansion by 300 bps.

¾ Pulp expansion at Ballarpur plant should add Rs 1.2 bn to EBITDA

BILT has plans to further increase its pulp capacity by 170,000 mt at its Ballarpur plant.

This includes putting an old pulp plant with capacity of 300,000 mt and phasing out

existing pulp plant with capacity of 130,000 mt. Estimated cost for this plan is Rs 5 bn

(US$ 110 mn) and it is likely to be completed by Feb ’12. We estimate benefit of Rs 1.2

bn from this capex as an addition at EBITDA level.

Capex will help EBITDA margins reach previous levels of 25%

With commissioning of above two plants, company’s captive pulp capacity is expected to

increase from 340,000 mt (excluding RGP) to 670,000 mt thus reducing its imported pulp

requirement from 40% at present to mere 8%. This is expected to help the company in

regaining its EBITDA margins of previous levels of 25% from current 20%.

Listing of subsidiary BPH is expected by Apr ’11

BILT has plans to list its subsidiary BPH by Apr ’11. At present, BILT holds 79% in BPH

which is expected to come down to approximately 65% (depending upon valuations of the

subsidiary). The company has plans to raise approximately US$ 300 mn through this listing

and is expected to utilize this fund in reducing its debt by US$ 140 mn and balance US$

160 mn would be used to fund its ongoing capex.

Downgrade FY11E /FY12E estimates by 35% / 6.5% to Rs 3.4 / Rs 5.1....

On account of continuous pressure on company’s EBITDA margins, we downgrade our

FY11 EPS estimates by 35% to Rs 3.4 from Rs 5.2. We also reduce our FY12 EPS

estimates by 6.5% to Rs 5.1 from Rs 5.5.

… However maintain BUY recommendation on attractive valuations and

triggers from listing of subsidiary

We believe that BILT’s paper expansion (without increasing the corresponding pulp

capacity) has been adversely affected due to unfavourable spread between pulp and paper

prices and has put pressure on company’s EBITDA margins. However pulp prices have

started softening and with paper prices remaining stable, we expect EBITDA margins to

improve going forward. Further its ongoing capex, to reduce its dependency on imported

pulp will help the company regain its previous margin levels with stable outlook. Also the

listing of its subsidiary - BPH (expected by Apr ’11) may trigger re-rating of the stock. With

comfortable valuations at FY12E P/E of 6.1, EV / EBITDA of 4.8 and 20% discount to book

value, we maintain our BUY rating on the stock with price target of Rs 42. At our target

price, the stock trades at FY12 P/E multiple of 8x and 1x Book value which is in line with its

historical average.