Current Price: Rs 59

52-week High/low:Rs 147/46

Recco: BUY

Improvement in international paper prices, declining imports and lower discounts will be the key factors driving Tamil Nadu Newsprint and Paper Ltd `s (TNPL) earnings at a CAGR of 86 per cent over the next two years, after a highly disappointing performance in fiscal97.

The stock has come off by 55 per cent over the past year and is currently trading at a growth adjusted PE (GAPE) multiple of 0.29, which is a discount of 57per cent to the market GAPE. At a 57% discount to the market, the stock looks cheap and has the potential to increase substantially from the current price.

The international paper prices are expected to increase slowly during the year. Improving international demand and the government's recent efforts at restricting newsprint imports to actual users, have alleviated the excess supply position in printing and writing paper (PWP).

Due to the commodity status, the stock should trade at a discount of approximately 25% to the market GAPE. At the current market price, the shares are trading at a mu]tiple of 13 times FY98 earnings and 7.3 times FY99 earnings. Since got listed in January 96, TNPL's stock price has declined by 67per cent due to weakness in the Indian paper market and declining international prices. In addition, due to the poor state of the Indian paper industry, investor interest in the stock was minimal, which led to poor volumes and low liquidity on the counter. With increasing paper prices and improving sentiment, we not only expect volumes to improve but also a re-rating of the PE multiple. The downswing in the international paper and newsprint cycle is now over and prices have bottomed. Hence, we assume price increases of 6- 4 per cent for newsprint and PWP respectively. TNPL's operating profit margin declined sharply to 28 per cent in FY97 from a level of 42 per cent in the previous corresponding year. This was due to lower global prices, increasing excise tariffs and a heavy import onslaught, which forced to reduce its prices and also offer heavy discounts.

During FY97, the company was forced to reduce its newsprint price by 34 per cent and offer heavy discounts on PWP. We estimate the total discount offered by the company in FY97 at Rs 2,373 which is 150 per cent higher than the average discount offered during FY96. Due to two price increases in newsprint and one hike in PWP prices, and lower discounts we expect margins to improve to 30 per cent in FY98.

TNPL embarked on a capacity expansion exercise in 1993. Under the RsS.8bn expansion, which was completed in FY96, the total capacity (printing & writing paper and newsprint) was doubled from 90,000 tonnes to 180,000 tonnes. While the company's plans at the time of the expansion were to dedicate the entire 90,000 tonne incremental capacity to newsprint production, due to the higher margins in printing and writing paper, the company is using the incremental capacity to produce PWP.

The technological flexibility to shift the production between newsprint and PWP is a strong advantage and helps the company to leverage itself strong]y to shifts in demand between PWP and newsprint. Indeed, with the current weakness in newsprint the company has restricted newsprint production to only 25 per cent of the total production. We view the flexibility in shifting the product mix as the key determinants of the near 100 per cent capacity utilisation rate achieved by the company over the past seven years.In order to part finance the expansion project, TNPL made a public issue in November 1995, which was priced at Rs 110. However due to the high premium and poor market sentiment, the Rs2.2bn issue devolved on the underwriters. Consequent to the issuance, the Tamil Nadu government's stake and the IDBl's stake in the company's equity has reduced to 35 per cent each.

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