Seshasayee Paper & Boards Ltd Management Discussions.

(i) Industry Structure and Developments Global

Paper Industry, occupies a prestigious position, among the various manufacturing enterprises, in view of its significant contribution to the Society. Role of paper in promotion of literacy and education, propagation of information and knowledge and in packaging of commodities of commercial value, makes it an indispensable product. Its hygiene products offer appropriate solutions to societys needs.

Despite predictions that the on-going digital revolution would make paper obsolete, paper remains central to our lives. Paper is interwoven with human life in innumerable ways. Think of the hundreds of times, we touch paper, everyday. Paper is a bio-degradable product with a benign foot print at the end of its life cycle and this adds further strength to this product, promoting its growing usage.

Paper Industry is a significant player in the World Economy. Its annual revenue exceeds US $ 500 billions. World consumption of paper and paper boards grew from 169 million tonnes in 1981 to 253 million tonnes in 1993 and to 352 million tonnes in 2005. Current consumption is in excess of 400 million tonnes. Paper usage has been declining in North America and Europe since 2006 while steeply rising in China and other Asian Economies. About half of the paper produced each year is recycled. (200 million tonnes).

As per Fisher International, share of major players in global production capacity in 2019 was:

China 26% India 4%
USA 15% Germany 4%
Brazil 6% Canada 4%
Japan 5% Others 36%

The four key Paper and Board categories are: Newsprint, Printing and Writing Papers, Paper Boards for packaging applications and Tissue Papers & other Speciality Papers. Packaging grades account for over 55% of consumption, printing and writing grades over 32%, tissue papers 8-10% and others about 3%. Tissue and packaging grades are expected to witness higher growth rates, in future while newsprint and printing and writing grades may witness declining trend.

Global demand for paper and paper board is forecast to grow to 482 million tonnes in 2030, or 1.1 per cent per year, according to a global paper market insight study by Poyry Management Consulting. The study forecasts the graphic paper market facing huge challenges, in particular, due to shrinking of demand for newsprint as well as uncoated and coated wood containing and wood free papers. Demand for tissue paper, container boards and carton board, is expected to grow upto 2030, driven by increasing packaging needs in emerging markets, booming e-commerce and the growing demand for convenience food and consumer goods. The annual consumption of packaging material and tissue / hygiene products is estimated to rise by upto 2.9 per cent.

Prior to COVID-19

Moodys, in their 2018 report, had predicted that the outlook for the global Paper and forest products Industry would be Stable based on a boost to income by 2% -4% over the next 12-18 months.

Higher prices, productivity improvements and synergies from recent acquisitions, as well as stronger wood product, paper packaging and market pulp demand, will drive profit growth, said Moodys outlook report. "This will be partially offset by lower paper demand and rising freight, labour, energy and chemical costs. Fibre prices, typically the largest input cost for most of the industrys products, will be volatile, but average 2018 costs will be flat compared to average 2017 costs"

As per "Paper-360" -a publication of TAPPI, healthy gains in packaging and tissue outweighed the slide in graphic paper demand in 2016, allowing global paper and paperboard demand to grow by 1%, or 3.9 million metric tonnes. In addition, this growth comes despite global graphic paper demand shrinking by 2.6% in 2016, its second-worst performance ever outside of a recession. The worst non-recession performance by global graphic paper demand occurred in 2015, when global paper and paperboard demands anemic growth of just 0.3% also represented its worst non-recession year ever.

China is the largest consumer of paper and boards with more than 100 million tonnes annually. China is also the biggest importer of recovered paper and producer of recycled paper. The Chinese Environment Paper Network (CEPN) has flagged its major concerns like, Pollution of water from untreated mill effluent, sourcing of fibre for Mills, imports of pulp from countries causing deforestation, insufficient levels of wastepaper recovery and wasteful use of paper. According to RISI, in China, graphic markets have transformed because of use of electronic media and economic restructuring in recent years. Chinas economic growth has slowed from 9% -10% per annum in 2009-10 to close to 7% in 2014-15 and to less than 7% in 2018-19, as the Government seeks to re-orient the economy from investment driven growth to consumption driven growth. This, combined with a major shift toward digital media usage has slowed Chinese graphic paper demand growth. RISI estimates that demand declined 1% -2% from 2014-15, a strong contrast to the 6% -7% demand growth that the market experienced from 2009-10, onwards.

Post COVID-19

"Post COVID-19, the pandemic has caused widespread concern and economic hardship for consumers, businesses and communities across the globe. Manufacturers are facing unique challenges caused by the crisis and forest paper and packaging producers are no exception" as per a Report from PWC.

The report adds that the companies in the sector must navigate the challenge of simultaneously safeguarding employee well being, managing potentially disrupted supply chains and evaluating tumultuous economic and capital market conditions.

Outlook for the Industry (both global and domestic) post COVID-19 is discussed in subsequent sections.

Domestic

Indias paper production, in the year 2017-18 is estimated at 18.91 million tonnes as per CPPRI. This would put the per capita consumption of India at 15 kgs. Indian Paper Manufacturers Association had estimated the annual growth rate to be 6.82% and has projected per capita paper consumption to reach 17 kgs in the year 2025. India ranks as the 5th largest producer of paper in the world. However, the Indian Paper Industry accounts for a meagre 4% of global paper demand. The per-capita consumption of 14-15 kgs is significantly lower than the world average of around 57 kgs. Indias per capita consumption is considerably lower than Chinas 65 kgs, Indonesias 22 kgs, Malaysias 25 kgs, and of course USAs 312 kgs consumption levels. This indicates the ample scope available for expansion of the Indian Paper Industry.

While the market size and per capita consumption are relatively low, they have exhibited a rising trend over past several years, from 9.3 million tonnes in 2008 to 17.37 million tonnes in 2016. As per CARE Ratings, the total paper consumption has grown at a CAGR of around 6.4% over last decade with none of the last ten years showing a decline in consumption demand. The long-term demand outlook for the Indian paper industry remains favourable, driven by increasing literacy levels, growth in print media (particularly in the vernacular languages), higher government spending on education sector, changing urban lifestyles as well as economic growth. Given that these factors are likely to be sustained, the paper industry is likely to continue growing at a rate of 6-8% per annum in the medium to long term although there may be aberrant years given the cyclical nature of the industry.

CRISIL however expects paper demand to grow between 5.5% and 6.5% between now and 2020-21, Demand for paper board is expected grow at a healthy 7.0% -7.5% over the next 5 years. Printing and writing paper is expected to capacity rise at 4% -4.5% CAGR against 3.6% between 2010-11 and 2015-16 on account of a likely pick-up from the education sector with improving literacy rates and Government schemes. Speciality Paper is expected to continue growing at about 9%-11%. The Indian Paper Manufacturers Association (IPMA) estimates the domestic market sizes to be around 17.19 million tonnes comprising Newsprint 2.6 million tonnes, Printing & Writing Grades 5.0 million tonnes, Packing Paper and Paper Boards 8.7 million tonnes, Tissue 0.17 million tonnes, MG Grades 0.24 million tonnes and others 0.35 million tonnes.

IPMAs estimate for growth of the Indian market is 6.5% per annum, with Printing and Writing Grades set to grow by 4.86%, Packing Grades by 8.37% and Tissue by 17.75%.

The Industry, faced considerable challenges in 2014-15 and in 2015-16, resulting in build-up of inventory and erosion in manufacturers margins. Poor growth in demand, consequent on a sluggish economy, unabsorbed excess capacity in the Industry, product substitution and competition from imports were largely responsible for the lacklustre performance of the Industry. However, the Industry is projected to grow to reach 23.00 million tonnes of production by 2024-25, driven by the enhanced emphasis placed on education and promotion of literacy by the Government and higher demand for packaging grades due to rising retail trade and e-commerce.

Paper Companies posted a sharp turnaround in 2017-18 and 2018-19. Domestic paper demand remained buoyant as closure of stressed domestic capacities led to supply constraints. Reduced Raw

Material and power prices had aided profit growth, according to Money Control.com The Indian Paper Industry is highly fragmented. As per CPPRI, there are over 800 paper mills in operation in the country, with an installed capacity of 25.17 million tonnes and operating at over 80% capacity utilisation. On the supply side, the industry saw significant of 1.6 million MT during FY09-FY11 (~15% of domestic paper capacity in FY09) particularly in the Printing and Writing Paper segment. The bunching of these capacities resulted in over-supply scenario during FY11 and FY12 as these incremental capacities could not be absorbed in the market. As a result, most players saw significant build-up of inventories as well as pricing pressures from FY12 onwards. But with steady growth in demand, the market has now started absorbing these incremental supplies. According to Poyry, India will witness highest annual growth of about 6.5% per annum while Chinas growth is projected to be in the order of 5.25%, in the near term. North America and Japan may witness marginal or negative growth. Amongst the various grades, Container Boards, Tissue Paper, followed by Carton Boards will witness higher rates of growth, while growth rate of Coated / Uncoated wood-free Paper is expected to be under 2%.

(ii) Opportunities and Threats

The competitive strengths and the opportunities that are available to the Indian Paper Industry are:

its large and growing domestic paper market and potential for export.

Governments thrust for improving education and literacy levels in the Country. growing urbanisation and e-commerce activities. fast growing contemporary printing sector. availability of qualified technical manpower with capability to design, build and manage world scale pulp and paper mills. well established Research and

Development (R & D) facilities / activities encouraging innovation. potential for creation of sustainable raw material base through farm plantations for wood and agro residues.

The following competitive weaknesses and threats confront the Industry:

high cost of raw materials, including wood, non-wood and waste paper.

poor collection of used paper resulting in low recovery rate and undue dependence on imports to meet domestic needs.

absence of policy measures for creation of sustainable raw material base through industrial plantations and used paper recovery.

likely closures, owing to increasingly stringent environmental regulations. lack of global competitiveness in costs and quality.

increasing imports consequent on numerous Regional Trade Agreements (RTAs) / Free Trade Agreements (FTAs) entered into by the Govt without adequate safeguards.

increasing competition from electronic media and digital communication alternatives.

Paper Industry is capital intensive and yields poor returns on investments. To enhance the competitiveness of the Industry, Government must address the issues of creation of robust raw material base as well as extending fiscal incentives for assimilation of eco-friendly technologies, etc. International Competitiveness is the key issue that is confronting the Indian Paper Industry, today especially in the context of Governments resolve to bring down import tariff every year and RTAs/ FTAs entered into with ASEAN / SAARC countries. The major players, alive to the emerging international threats, have been aggressively pursuing quality improvement programmes, coupled with cost rationalisation and capacity additions. Increasingly, more up-to-date technologies are sought to be implemented, with added focus on environmental compliance.

(iii) Segment wise or Product -wise performance

The Company is a single product Company and hence, segment-wise or product-wise performance is not provided.

(iv) Risks and Concerns

Post COVID-19, a huge downturn in the fortunes of Paper Industry is predicted. Ind-Ra expects a decline in paper demand in FY 21, given the hit on demand from packaging, education, corporate and print media sectors due to the prolonged nation-wide lockdown.

Printing and writing paper segment which is the prime grade among companys products, is expected to be impacted more severely in the near term.

The company is taking necessary steps to weather this storm by strengthening its marketing network, as well as the supply chain in addition to maintaining its liquidity to overcome extended periods of low-sales and poor revenue collections.

Failure of Monsoon and absence of water flow in the River Cauvery, from where the Company draws its water requirements, had created anxious moments to the Company in the past. Such contingency has recurred in the past forcing the Company to curtail production and alter the product mix. Further, inter-state sharing of River Cauvery water has become a political / legal issue in recent times. The Company is taking various initiatives to curtail quantum of water used in the process and has taken steps to identify ground water resources (which are meagre) within the Mills premises.

Continuous failure of monsoons resulting in scanty rainfall in the State of Tamil Nadu, had also affected substantially planting of sugarcane. This had brought down, significantly the availability of cane for ‘crushing by sugar mills in the State, including by our Group Company, Ponni Sugars. Bagasse availability, consequently, has been significantly affected in the past. This trend continues.

While there has been some improvement in the availability of wood from within the State, unprecedented shortage of wood felt in the neighbouring State of Andhra Pradesh in 2013-14, which has been the primary sourcing point for the Andhra based mills and few upcountry Mills had forced these mills to turn to Tamil Nadu for meeting, at least a part, of their shortfall. This has seriously affected the availability and cost of wood for the Tamil Nadu based mills.

With this mismatch of supply and demand, price of casuarina wood had skyrocketed by over 50% during 2013-14 and 2014-15, causing serious erosion in the profitability of operations. If this trend is to resurface again in future, the Company may have to resort to import of wood logs/chips at higher prices, to sustain production. The supply side constraints have since eased, and availability of wood improved.

The Company has taken steps to step-up production of clonal seedlings and bare-rooted seedlings by the Companys nursery as well as by the company sponsored nurseries, to support planting of nearly 14.50 crores of Casuarina and Eucalyptus seedlings in about 6720 ha by small and marginal farmers in Tamil Nadu.

The Company depends entirely on imported coal for operating its Captive Power Plant. The price of imported coal witnessed an unprecedented increase of more than 100% during 2007-08. Prices which softened from second half of 2008-09, have shown a rising trend currently. Profitability of the Company will be impacted by possible price increase of Coal as well as possible weakening of Indian Rupee, considering the dependence of the Company on Imported Coal.

Undue haste in reducing tariffs, for imports from countries covered by Government of Indias RTAs / FTAs, will likewise expose the Industry to inexpensive imports from low cost producers of paper. exchange rate Undue fluctuation between Indian Rupee and US Dollar will impact the margins of the Company.

(v) Outlook for 2020 Global

After strong growth in 2017 and early 2018, global economic activity slowed notably in the second half of last year. According to an IMF Report, Chinas growth declined in following a combination of needed regulatory tightening to rein in shadow banking and an increase in trade tensions with the United States. The euro economy lost more momentum than expected as consumer and business confidence weakened.

Germany was disrupted by the introduction of new emission standards, investment dropped in Italy as Sovereign spreads widened and external demand, especially from emerging ASIA softened.

It is in this background, almost overnight, the trajectory of the global economy has changed completely. Heading into 2020, there was some minor lingering concern about continued deceleration in China. However, the US economy was demonstrating underpinnings of strong growth, Europe was muddling along as expected and the slowdown in China seemed to be easing.

The consensus outlook was for a stable first half of the year, before seeing an acceleration in the latter half of 2020 and into 2021.

As report from RISI states "the COVID-19 pandemic has changed that picture drastically. Now, China is in the very early stages of recovery after implementing draconian measures to contain the virus. The delayed response in the US and Europe is quickly evolving into a strong and all-encompassing response. The economic impact from these measures will be exceptionally disruptive, and has increased the likelihood of a recession significantly. The global economy has already shown signs of substantial slowing, and the downside risk has risen exponentially in terms of both likelihood and severity".

The pandemics impact will be particularly

US, where consumer significant demand has been the key driver for economic growth in recent years. With consumption down and business interactions significantly limited due to restrictions, curtailments and quarantine, major economic growth contributors are missing. The service sector is likely to be one of the most vulnerable, and its potential problems could cause the rebound in growth to be somewhat slower than expected.

According to Moody‘s outlook for the global paper and forest products, industry remains negative.

This reflects Moodys expectation that the industrys global operating income will decline five to seven per cent over the next 12-18 months. Declining demand and lower paper packaging (both corrugated and consumer packaging), commodity paper and market pulp prices will be only partially offset by increasing wood product prices and modestly stronger demand for tissue, specialty paper and pulp.

Coronavirus will pressure demand and drive prices lower. The global economic outlook is deteriorating as the outbreak spreads. While logistics disruptions may temporarily slow paper and forest product exports to and from China and other affected areas, such as Korea and Italy, the impact on global demand will likely be far worse than on global production. This will result in oversupply across many regions, which will drive prices for most grades lower.

Domestic

Ind-Ra expects a decline in paper demand in FY 2021, given the hit on demand from packaging, education, corporate and print media sectors due to the nation-wide lockdown, continued disruption in industrial production and supply chains for 20-30 days thereafter and lingering infection concerns for a few weeks. Ind-Ra expects a recovery in demand in Q-2 of FY 2020 with resumption of education and corporate sectors, driving demand for writing and printing paper (WPP) and a gradual normalisation of manufacturing and logistics, pushing packaging demand. However, there could be downside risks if the lockdown is extended. Besides, domestic paper producers have already been facing volume pressure from rising imports, which grew 18% yoy in 10M of FY 2020, significantly faster than the growth in domestic demand. While logistical disruption could provide a temporary relief, the import threat continues with subdued pulp prices and the possibility of overseas manufactures pushing their inventory amid a weak global demand, post normalisation of logistics.

Demand for WPP is hit by the closure of most educational institutions since the beginning of March and a gradual adoption of work from home (WFH) by companies. Professional courses could see a higher usage of the digital platform in the near-term. With restrictions and concerns around the COVID-19 pandemic, Ind-Ra expects WPP demand to be the worst hit in Q-1 of FY 2021. Import threat looms after temporary respite. Paper import, which accounts for 15%-20% of the domestic demand, grew around 18% yoy in 10M of FY 2020 with a moderation in global pulp prices. Ind-Ra however believes the imports would get constrained till normalcy is restored in India, post which Chinese manufactures are likely to push the built-up inventory, though Rupee depreciation will impact prices. This, coupled with a subdued demand environment and high stocks in the supply chain, would weigh on paper prices for most of the grades.

(vi) Internal control systems and their adequacy

The Company maintains all its records in ERP system developed in-house and the work flow and majority of approvals are routed through this system.

The Company has laid down adequate systems and well drawn procedures for ensuring internal financial controls. It has appointed an external audit firm as Internal Auditors for periodically checking and monitoring the internal control measures.

Internal Auditors are present at the Audit Committee Meetings where Internal Audit Reports are discussed alongside of management comments and the final observation of the Internal Auditor.

The Board of Directors have adopted various policies, like Related Party Transactions Policy and Whistle Blower Policy and put in place budgetary control and monitoring measures for ensuring the orderly and efficient conduct of the business of the Company, the safeguarding of its assets, the prevention and detection of frauds and errors, the accuracy and completeness of the accounting records and the timely preparation of reliable financial information.

The Company has enlisted the services of an external firm of Chartered Accountants to evaluate the adequacy of the internal financial control systems adopted by the Company. They have expressed satisfaction with the existing internal financial control system prevalent in the Company.

The Statutory Auditors have also expressed satisfaction with the existing system in their Audit Report to the Shareholders.

(vii) Discussion on financial performance with respect to operational performance

2019-20 2018-19
(in tonnes) (in tonnes)
Production 1 97 547 2 09 015
Sales 1 87 271 2 07 971
(Rs. in crores) (Rs. in crores)
Profit before interest, depreciation, exceptional item and tax 290.71 318.90
Finance Cost 6.89 13.81
Depreciation 35.00 33.78
Profit before tax 248.82 271.31

The Management reviewed the significant changes in the financial ratios and have noted a favourable and positive change in most of the ratios due to better operational performance, in-spite of adverse market conditions, as explained later in this section.

Financial Year % Change - Remarks
2019-20 2018-19 Inc / (Dec)
1 Revenue from Operations (RFO) - Rs. in crores 1183.98 1325.24 (-)10.7% • Drop in Volumes by 10.0% and balance due to drop in Net Realisations.
Ratios -% on RFO
2 Other Income 2.0% 1.7% 16% • No Major Variance.
3 EBIDTA Margin 24.6% 24.1% 2% • Company could marginally improve on margin %,
4 PBIT Margin (Operating Margin) 21.6% 21.5% -- inspite of the adverse market conditions.
5 PAT Margin 14.7% 14.3% 3%
Other P&L Ratios
6 Return on Net Worth (PAT / Equity) 17.5% 21.9% (-) 20 % • Drop in % terms is mainly due to expansion of Net Worth in the current year and drop in absolute value of PAT.
7 Interest Coverage Ratio (PBIT / Interest) in times 37.11 20.65 80 % • Better Operating margins and repayment on Term Loans resulting in better interest coverage.
Balance Sheet Ratios
8 Gross Debt (^^) to Equity Ratio 1 : 97.8 1 : 8.9 • Significant increase in operating margins and reduction in cash conversion cycle resulted in significant increase in cash generation, which consequently resulted in Improvement in significant the Debt Equity Ratio.
9 Net Debt to Capital Ratio (-) 45.9% (-) 32.4% • Net Debt to Capital Ratio is Negative due to the cash and bank balances being significantly higher than the Gross Debt.
10 Networth per Share (Face Value of Rs. 2 each) 158.32 137.59 15 % • Consequent to increase in Retained Earnings, as a result of higher Total Comprehensive Income.
11 Current Ratio ## 2.61 2.03 • Increase is mainly due to increase in inventories, reduction in trade payables and reduction in other financial liabilities.
12 Debtors Turnover Ratio (as a % on RFO) 6.8% 6.0% • Marginal increase due to the tough market conditions in the month of March 2020.
13 Inventory Turnover Ratio (as a % on RFO) 14.3% 10.2% • Mainly due to Finished Goods Inventory at the end of current year, as against NIL Finished Goods Inventory at the end of previous year.

## For Current Ratio, Current Liability excludes The Company registered a lower PBT in absolute value, by 8.3% compared to previous year, mainly due to nationwide lockdown announced by Government, disrupting plant operations and higher finished goods inventory of Paper at the close of March 31, 2020, with most markets in India and abroad closed down, during the last week of March 2020 amidst Covid-19 pandemic.

Even amidst adverse market Conditions, the Company could maintain the margin %, at marginally better levels than previous year. The negative impact, arising out of drop in sales volumes and reduction in Net Sales Realisations in the current year, as compared to previous year, was partially offset by the following factors, that resulted in sustaining the Operating Margins, at same levels of previous year :

Lower cost of key input materials like

Wood, Imported pulp, Waste Paper and Coal.

"Current Maturities on Long Term Loans".

Improved Operational efficiencies.

Optimisation in Raw Material Mix and Chemicals.

Lower Interest and Financing Charges, due to repayment of Term Loans and non-utilization of working capital limits.

(viii) Material developments in Human Resources / Industrial Relations front, including number of people employed

Relations between the Management and the labour were cordial throughout the year under review. The five year wage / salary agreement with labour unions / Staff Association expired on March 31, 2019. Negotiation are underway for entering into a new agreement.

Currently, the Company employs 1 290 persons of all ranks in its two Units.