Sirpur Paper Mills Ltd Management Discussions

GLOBAL PERSPECTIVE

The paper industry performance is influenced by economic growth, industrial production, promotional expenditure, population growth, global trade, corporate prosperity, literacy, advertising and demand-supply dynamics.

Across the world, the paper and paperboard industry produces about 400 million metric tonnes and is dominated by North America, Western Europe and Japan. While over 50% of the consumption is in the developed economies, demand growth for writing and printing paper is modest in these mature markets. Consumption in Asia, primarily China, India and Indonesia are growing faster than in the developed markets attracting fresh investments in these countries.

As in the case of writing and printing (W&P) paper, demand for the packaging grades are also growing faster in the developing economies compared to mature markets of North America & Western Europe.

Major paper producing countries of Latin America, Europe and Asia, including China, Indonesia, Malaysia and a few others have adopted a policy of granting forest concessions to large paper mills to plant, protect and harvest pulpwood in a cost effective manner. In the absence of similar enabling policies, paper mills in India have to necessarily depend upon farmers holding barren, marginal and degraded lands for plantations developed through the industrys social forestry initiative or from government controlled forests. In the process, the cost of collection and transportation works out to be greater than the cost of the pulpwood itself. Raw material cost in India has been continuously going up and has become most non-competitive in comparison to the major paper producing countries in the world.

During the year, the global paper business scenario was mixed with high feedstock prices, low demand growth but with low capacity addition. Global growth picked up in the second half of 2013-14, averaging 3.5% - a marked uptick from the 2.5% recorded during the previous six months. The impulse has come mainly from advanced economies, although their recoveries remain uneven. Global paper activity is expected to improve further in 2014-15.

INDIAN PAPER INDUSTRY

Indias GDP growth is expected to recover from 4.4% in 2013-14 to 5.4% in 2014-15, supported by slightly stronger global growth, improving export competitiveness and heightened industrial activity.

Paper industry is positively correlated to GDP growth trends. Anecdotally, every 100 bps improvement in GDP enhances paper demand in India by 1 kg per capita. The industry therefore hopes that the GDP growth is secular and translates into consistent and continuous growth for the paper industry.

Indian paper industry is among the 15 largest paper industries in the world. The Indian paper industry is a major contributor to the nations growth and development. It is in this spirit that the Indian paper industry has continued to upgrade its capacities and technologies.

The domestic demand for all varieties of paper in India is estimated at around 13.10 million tonnes per annum which is about 3% of global demand of 400 million tonnes even though Indian population of 121 crore as per 2011 census constitutes 17% of the world population. Of this, writing & printing paper accounts for approx. 4.10 million tonnes, packaging grades approx. 5.90 million tonnes and newsprint about 2.50 million tonnes apart from specialty grade about 0.60 million tonnes.

Even though the domestic paper consumption has been growing steadily, it is still below 10 kg per capita, which is abysmally low when compared to highly populated and developing economies. For instance, per capita consumption in China & Indonesia is estimated at 75 kgs and 23 kgs, respectively.

Paper industry is capital intensive and in order to raise the return on investment, it requires the urgent attention of the government for creation of robust raw material base, fiscal incentive for assimilation of eco-friendly technologies etc. The economic survey of 2013-14 clearly highlights drying of investment in projects in the economy and the paper industry is not isolated from the same. The working results of the Indian paper industry continued to be adversely affected by the overriding sluggish market conditions coupled with a steep hike in the cost of raw materials together with deteriorating quality, chemicals, coal and furnace oil. The upward revision in minimum wages, finance charges etc., put added pressure on the margins.

Continued reduction of peak import tariff by Government of India will expose the industry to flood of import and will significantly alter the fortune of the industry. Mills from South Asia started offering pulp & paper at very low prices as a means of evacuating their production.

Improvement in the market sentiments has had a positive impact on the economy since early 2014.

As a consequence, paper market has taken a positive turn and expects that results for the current year should improve, with better sales realisation.

Key growth drivers for paper industry in India: The growing Indian economy will create more demand for paper due to:

• More jobs will create higher demand for office/ printer paper;

• Focus of government on education;

• Increasing literacy levels;

• Circulation/readership of newspapers/ periodicals increasing;

• Higher usage of packaged products;

• Focus on marketing campaigns for products;

• Increased demand from hygiene/hospitality sector.

SIRPUR PAPER - A PERSPECTIVE

Indian paper industry witnessed another disappointing year. While paper prices improved to some extent towards the end of the financial year, this has not been adequate to cover the steep increases in input costs of pulp wood, coal, freight etc. Consequently, margins for Sirpur Paper Mills (SPM) remained under severe pressure throughout the year. Production and turnover was higher than previous year despite high level of competition. Efforts were made to improve efficiency at all operational levels, thereby minimizing the impact of cost increase of various inputs. SPM exercised strict control over expenses, however, certain expenses, which are under government control or in short supply, remained beyond the control of management. Paper industry is capital intensive requiring increased funds to ensure business continuity as a result of which cost of debt is a critical determinant of success.

To be globally competitive and a low cost producer of paper, SPM focused its attention on the following strategies:

• Effective consumer centric engagement;

• Innovative, effective cost management of materials and production process;

• Efficient and responsive supply chain network;

• Improvement in brand health and market standing;

• Better utilization of human resources, finance & assets;

• Financial re-engineering;

• Upgradation of technology and expansion;

• Customised product development;

• Enhanced accountability & transparency;

• Dedicated social obligation.

Marketing & distribution

Despite such a challenging business scenario, SPM has successfully enhanced its market standing through robust strategies and excellence in execution. SPM will continue to invest in development of products that are best-in-class and offer superior and differentiated value propositions to consumers.

The Company remains confident that despite severe pressures, its robust product portfolio, better quality, innovation in processes and investment in cutting-edge technology and superior execution of competitive strategies will enable SPM to sustain and reinforce the market standing in the years to come.

Gross revenue from operation increased in current year by 19% to Rs 444,34 lakhs from Rs 372,44 lakhs in the previous year. Net revenue from operation in 2013-14 increased to Rs 417,54 lakhs from Rs 349,92 lakhs in the previous year.

Raw material

The basic raw material of the Company is bamboo/ wood. Wood is in short supply due to both heavy increase in demand and lack of interest of farmers to grow this commodity vis-a-vis other cash crops. A scarcity in raw material supply is a threat. In paper manufacture, the question of raw material security is more relevant than in most other industries because the rampant exploitation of raw material sources could have a climatic impact.

The growing paper demand could soon lead to a sharp increase in raw material costs. Sirpur is advantageously placed in this regard. The Companys plant is situated at Kagaznagar in Telangana, a state where sizeable land is under forest cover. The Company sourced 80% of its wood requirements through Agricultural Marketing Committees -government regulated agency - at government determined prices. The dearth of raw materials is affecting all paper companies as manufacturers are not allowed to own land to raise plantations for captive pulpwood supply, impacting growth and achieving economies of scale. Total cost of material consumed increased in the current year by 42% to Rs 243,28 lakhs from Rs 172,35 lakhs in the previous year.

Research & development

Over the years, Sirpur has made product research and innovation inseparable from product manufacture. This has helped it expand existing customer business and reach out to new customers while achieving superior realizations. It invested increasingly in research to upgrade and modernize plant operations. At Sirpur, research and development spending encompassed three areas of trouble shooting, process and quality improvement besides product development.

In its continuous pursuit of increasing the product range, producing superior products and enhancing the production process, SPM notably achieved the following:

• Successful use of certain types of Indian hardwoods with bark, which have not been tried so far in the paper industry. This helped the mill in overcoming the raw material shortage to some extent;

• Keeping in view the market demand, certain new products in different colours have been developed, manufactured and supplied to the market. These are expected to increase the product range apart from opening up new avenues for marketing;

• Introduced machine spray starch sizing system on one paper machine to enhance its paper properties;

• Usage of spent chemicals of some other industry as raw material in the process; thus not only saving the natural resources but also helping the other industry to minimize their waste disposal and associated pollution problems;

• Process modifications had been carried out in the processes to reduce the cost of production of certain grades of paper without sacrificing the quality of the products, particularly the coloured varieties.

SPM aims to relentlessly enhance quality, enhance productivity and introduce new and value added products to meet the customer requirements.

Internal control & audit systems and their adequacy

The Company has established adequate internal control & audit systems, which provide reasonable assurances with regard to safeguarding Companys assets, promoting operational efficiencies and ensuring compliance with various statutory provisions. The internal audit department regularly reviews internal control systems in business processes and verifies compliance with the laid down policies and procedures. Reports of the internal audit department are reviewed by the senior management and are also placed before and comprehensively discussed at the meetings of the Audit Committee.

The Audit Committee reviews the adequacy of internal control systems, audit findings and suggestions. The internal audit department also keeps a track of and monitors the progress on implementation of suggestions for improvements. The Companys statutory auditors regularly interact with the Audit Committee to share their findings and the status of actions under implementation.

Human resource development/industrial relations

The Company takes pride in its record of maintaining congenial and healthy industrial relations. During the year under review, industrial relations were harmonious at our unit. The wages settlement for workmen & staff are due for revision.

The industry is grappling with a decline in the availability of skilled manpower as well as those willing to work in remote locations where most paper factories are based.

The Company has adopted a progressive policy to develop its human resources through continuous training and motivation, to achieve greater efficiencies and competencies. Need based training programmes are conducted by internal faculty who are subject matter experts in their areas. Training programmes cover behavior, technical, health & safety aspect. In addition, on job training is also being provided. The significant progress made by the Company was possible in no small measure by efforts of the entire team.

SPM has taken concrete steps to improve organizational health by creating focused management teams with specific targets for growth in volumes and profitability while building and retaining talent. Safety, welfare and training at all employee levels continue to be areas of major focus for the Company.

Daily & periodic review meetings are conducted for senior executive and staff where developments in various department of the organization are discussed and appreciated. It is an integral activity of the company to give importance to develop the intellectual capital of employees through systematic structured training programmes.

HEALTH

Occupational Health Hospital has been functioning in the housing colony catering to the health needs of the employees and their dependents. The Company bears medical expenses apart from offering free medicine. Comprehensive medical checkup is done for employees to identify any occupational health hazard.

INFORMATION TECHNOLOGY UPGRADATION & EXPANSION

In order to progress business performance, SPM has implemented the following new business functionalities:

• Automation of workers attendance reports by discontinuing the manual records maintenance;

• Fine tuning the existing integrated weigh bridge software with SAP;

• Upgrade the customer portal;

• Enhancement of label printing for reams through SAP;

• Performance evaluation of biometric time and attendance system;

• In order to utilize SAP system effectively and efficiently, the central support team has completed the following activities during the financial year 2013-14:

a. Refresher training provided to all SAP users;

b. Preparation of end-user manual, which helps the users for smooth functioning of their day-to-day activities;

c. Development of new reports in FICO, MM & SD modules.

Going ahead, the Company will upgrade the existing SAP 4.7 EE version to latest SAP 6.0 ECC, so as to get continuous support from ERP. Other significant areas are being upgraded. The Company will implement business warehousing to facilitate business intelligence for better data analysis and reporting. Implementation of new pay roll package and integration with attendance system is another area to be planned.

ENVIRONMENT

SPM ensures that:

• Compliance with all relevant legislative requirement;

• Reducing pollution load in terms of liquid discharge, air emission and land contamination;

• Minimize waste and maximize recycling/reuse;

• Creating human awareness in environment safety and health;

• Promoting comprehensive programme for continual improvement of environmental performance;

• Stimulate rational use of resources through behavioral and technological improvements.

ANALYSIS OF FINANCIAL STATEMENTS

The Company recorded a production of 89,256 MT of pulp and paper in the year 2013-14 as against 83,085 MT in the previous year, an increase of 7.43%. The capacity utilization remained static on an annualized basis though it could have been better. Shortage of power availability from Government of Andhra Pradesh due to imposition of severe restriction & control measures impacted all the industries.

The availability of raw material, i.e. wood, continued to be poor in the year resulting in higher cost of raw material. The non-availability of raw material caused impediment in manufacturing. Increment in paper price was finally accepted by the market. In the meantime, sentiment of market was disturbed when the paper prices were increased. Sirpur witnessed accumulation of stock gradually since November 2013 which blocked working capital cycle & availability of funds for raw material.

In a capital intensive business, Sirpur required adequate low cost funds. While the Company moblised short-term funds to meet working capital needs, long-term loans were raised to meet capital expenditure. Finance cost increased from Rs 44,88 lakhs in the previous year to Rs 48,22 lakhs in the year under review. Increase in employee cost by Rs 2,52 lakhs in 2013-14 is attributed to hike in wages. There was significant reduction in stores & spares consumed by 14.76% from 17,20 lakhs in 2012-13 to Rs 14,66 lakhs in 2013-14.

In spite of setbacks, by process optimization Sirpur continued to focus on enhancing competitiveness through improved operational efficiency, conservation of resources, reduction in fiber loss and consumption of steam, power and water.

Several initiatives taken by the Company during the year increased gross revenue from operation by 19% to Rs 444,34 lakhs from Rs 372,44 lakhs in the previous year. Net revenue from operation in 2013-14 increased to Rs 417,55 lakhs from Rs 349,93 lakhs in 2012-13.

Loss before other items, finance costs, depreciation and tax was Rs 13,92 lakhs in 2013-14 as against a loss of Rs 14,60 lakhs in the previous year. Interest cost during the year, in view of the CDR package reduced marginally though fresh loan by way of FITL increased the overall finance cost to Rs 48,23 lakhs from Rs 44,88 lakhs. Depreciation was marginally lower at Rs 28,84 lakhs.

The loss after tax decreased from Rs 97,10 lakhs in the previous year to Rs 90,98 lakhs during the current year.

Cost analysis

The weighted average prices of the main raw material i.e. wood increased by over 42% which could not be passed on to customers fully. The impact of the input price hike was marginally set off due to the Companys incessant efforts in cost control, material management and productivity improvement. The borrowing cost of the Company on its term loan and working capital facilities reduced marginally.

The Company has initiated a number of concrete steps to overcome challenges. Most of these initiatives have already started yielding positive results. The team at Sirpur feels confident of significant further improvements as they move forward to reshape the Company into a healthy and fast growing organization.

Share capital & securities premium: The share capital of the Company during the year increased to Rs 16,99 lakhs from Rs 16,44 lakhs & an increase in securities premium by Rs 1,81 lakhs with the allotment of fresh ordinary shares during the year to a promoter group company.

Reserves and surplus: The reserves and surplus of the Company (without revaluation reserve) stood at Rs (45,38) lakhs

Loan funds

In view of the CDR package, repayments of term loan have been deferred till March 2014. Interest on term loans has been converted into FITL up to December 2013. Interest on FITL was duly paid during the year. Interest on term loans is payable monthly from January 2014. The Company continues to avail sales tax deferment loan.

On account of CDR scheme, the Companys long-term borrowings increased from Rs 308,46 lakhs to Rs 315,15 lakhs.

Utilisation of funds

The net fixed assets (without revaluation reserve) decreased from Rs 382,83 lakhs to Rs 356,24 lakhs on account of deprecation charged and sale of some old and obsolete assets. Additions to the fixed assets during the year was to the tune of Rs 11,69 lakhs.

Current assets & liabilities

Current assets as at March 31, 2014 were Rs 144,20 lakhs as compared to Rs 146,48 lakhs, a year ago. Current liabilities increased from 132,71 lakhs to Rs 186,87 lakhs, an increase of Rs 54,16 lakhs.

Inventories

There was an increase of about Rs 5,16 lakhs from Rs 40,96 lakhs to Rs 46,12 lakhs in holding levels of finished goods mainly due to less offtake vis-a-vis production, during the year 2013-14.

Trade receivables & payables

Trade receivables decreased from Rs 63,42 lakhs in 2012-13 to Rs 60,08 lakhs during 2013-14. The debtors cycle was at 55 days as against 65 days in the previous year. Marginal decrease in absolute amount of receivables was due to new market policy which favorably impacted the cycle time, on a comparative level. The trade payables increased from Rs 80,40 lakhs in 2012-13 to Rs 94,70 lakhs during 2013-14.

CORPORATE SOCIAL RESPONSIBILITY

In view of accumulated losses, the provisions of Section 135 of the Companies Act, 2013 are not applicable to the Company, relating to constitution of CSR Committee, till such time it meets the criteria specified in sub-section (1) of the said Act read with CSR Rules, 2014. SPM is always socially responsible and continuously strives to help develop the community. In pursuance of its efforts to make a difference, as always, the Company provided financial aids to various educational institutions, temples, mosque, and conducted sports and recreational programmes for the society at large.

In addition to these, the Company has taken up several initiatives such as providing training to the students in the fields of engineering, technology, business management; industrial training to polytechnic students; supply of water to the nearby villages; maintaining childrens park and recreation clubs etc.

OUTLOOK

SPM continues its relentless focus on strengthening competitiveness in its business. It is the endeavour of the Company to deploy resources in a balanced manner so as to secure the interest of the shareholders in the short, medium & long term. The Company has also taken several steps for operational restructuring which are expected to lead to higher efficiency/cost savings. Despite the challenges of the present, the Company looks forward to the future with confidence.

SPM sought flexibility from the lenders and a comprehensive restructuring of its outstanding debt was approved by the lenders under the aegis of the Corporate Debt Restructuring (CDR) platform. The Company has been sanctioned a moratorium of interest and principal for 21 months from the cutoff date i.e. April 1, 2012 and the payment commenced from January 2014.

In all the operations, the focus will be on improving assets utilization through market expansion & better penetration as well as margin improvement through internal efficiency and cost control measures. The aim is to deliver better value for all the stakeholders. Based on a positive outlook and the Companys inherent strengths, the team is confident of better performance in 2014-15 and beyond.