South India Paper Mills Ltd Management Discussions.

i) Industry Structure & Developments :

The Indian Paper Industry has been historically segmented on a three dimensional matrix identified by size, grades manufactured and raw materials utilised. Government policies on indirect taxation rates applicable to output have relied on this segmentation. Generally, tariff rates have protected smaller units utilising "unconventional" raw material. Over the years, the growth of various segments, investment levels in specific segments, technological changes, industry fragmentation and intensity of competition have been significantly influenced by the Governments tariff policy.

Over 600 players currently populate the domestic industry and the estimated output across all grades is about 19 million metric tonnes per annum (MTPA). Global paper consumption is about 400 MTs per annum and about 50% is recycled each year. The three broad segments of the market are Writing and Printing Grades (Cultural), Packaging Grades (Industrial) and Newsprint.

The "Industrial" Segment of the paper market broadly comprises of Corrugated Case Materials, (CCM) and Duplex Boards -white lined and coated or uncoated. Fragmentation is severe in this segment which constitutes about 50% of the total output of Paper & Board. This segment entirely relies upon "unconventional" raw material such as waste paper (imported and domestically sourced) and, to a limited extent, on agricultural residues. The average size of units in this segment is now about 15,000 MTPA and most units cater to local area demand from small semiauto corrugated box factories and small printers. Although the other segments in the Indian paper industry are also fragmented by international standards, the degree of fragmentation is less severe.

Historically, the bulk of the output of "Cultural" grades - comprising of writing, printing, office stationery paper and speciality paper has been the preserve of the larger producers, who use forest based raw materials in integrated pulping facilities augmented by imported market pulp. This segment has been consistently taxed at higher rates due to its size and use of "conventional" forest based raw material. Investment in plant for these players has also been higher. With a relatively smaller number of players and high import tariff protection, prices of end products, generally perceived to be of higher quality, have been high. "Lower end cultural grades" manufactured by smaller players using unconventional raw materials in low investment, low-tech plants cater to consumers in the price sensitive subsegment of this market. This sub segment has historically depended heavily on the tariff differential based on size and raw material for its viability. Some of the mid-sized players in the writing and printing segment are in the process of expansion and modernization and are installing wider/faster machines with full fledged de-inking plants to produce the higher quality that is increasingly preferred and for which consumers are willing to pay more. Several of the "large-integrated" forest based producers have also recently increased forest based pulping capacities The cultural paper segment contributes about 40% of the annual paper and paperboard production with a current demand growth rate of about 6 to 7% per annum. The high investment levels required and limited "conventional" fiber resources are the major deterrents to growth in this segment for both existing players as well as new entrants.

The Indian Paper industry which accounts for about 4.5% of global production, in recent times has registered faster growth rates of about 7%. The domestic demand is expected to grow at about 6 to 7% p.a. Paper industry plays an important role in the socio-economic development of the country.

Despite several infrastructural impediments there is a strong growth in demand in several sub-segments of the Indian Paper Industry. There is perceptible shift in preference for higher quality products in both the Industrial and Cultural Segments and players with the right grade-quality mix are seeing opportunities for profitable growth. As per our assessment, most of the dominant players in each industry segment are operating near to capacity and one can expect a round of capacity additions which will however be circumscribed by factors peculiar to individual units such as the ability to raise funds cost effectively, availability of raw material and low cost energy.

ii) Opportunities & threats:

The Indian Governments policy for the paper industry lacks perspective. It is necessary that the Government come up with a clear policy on pulpwood plantations that can benefit the paper industry in terms of introducing more virgin fiber into the fiber basket. In the face of fierce global competition, sustenance of industry with only agro-based raw materials and recycled fiber will be very difficult to achieve. The Government also needs to create a more conducive atmosphere for investment into this sector.

In the medium term, much of the growth in the packaging segment of the Industry is expected to be based on recycling of waste paper. This is already the trend in China. Indian paper companies in the packaging segment are also expected to fuel their near to medium term growth through waste paper imports from regions of surplus such as North America and Europe. Large Chinese producers have set up their own sourcing networks in these regions to supply their huge capacity additions; they possess relative buying strengths and constitute a cost threat to that extent. Over time, however, as domestic capacities stabilize and domestic collection improves, a larger proportion is expected to be sourced domestically with the fiber basket being upgraded by pulp imports. The strength of any firm in this industry is however expected to come from a presence throughout the supply chain from raw material to packaging production and delivery.

Whilst this is a capital-intensive industry, the current structure of depreciation tax shields, finance (interest) costs and relatively short-term repayment horizons places severe limitations on fresh investments.

This phenomenon has effectively increased the project cost on expansion and new green-field investments. At the same time, the continuous reduction of import tariffs keeps margins under pressure.

The absence of large-scale investments and green field projects in a rapidly growing economy with one of the lowest per capita paper consumption rates is testimony to this situation.

iii) Segment wise or product wise performance:

Segment wise revenue, results and capital employed are furnished for i) Paper & Paper products and ii) Power, in the notes on accounts.

iv) Outlook:

Growth rate of the Indian economy was negative at -7.3% due to Covid-19 impact as against 4.2% for 2019-20. Q4 had turned positive with 1.6% growth.Growth forecast for 2021-22 is 9.5% on the lower base figure of the previous year.

Demand for paper in FY 22 is expected to revive in the second half with reduced impact of Covid-19. Demand from education, packaging, corporate and print media sections declined owing to nation wide lockdown imposed to curb the spread of Covid-19 pandemic.

Innovative cost containment and cost cutting will be required by paper mills to not only maintain business volumes but to capture a larger portion of a slowly growing pie.

v) Risks and Concerns:

New, large scale manufacturing capacities are being created in several down-stream industries such as electronic goods, white goods, cell phones and fast moving consumer goods. These industries that have been seeing a year- on-year growth of 8 to 10% are expected to also slow but not as much as the general slowdown in the economy and Covid-19 impact.

The Government has also prioritized policies aimed at promoting rapid up-gradation in supply chain systems for retail distribution and export of fruits and vegetables. The automotive components industry is also growing and demanding wooden packaging substitutes. The footwear and garments exports segments are growing but at a more moderate pace as export markets slow.

All these and other trends indicate that there will be a better than average growth in the demand for high-quality, world-class packaging material produced in state-of-the art facilities and delivered just-in-time.

Whilst one would ordinarily expect these trends to encourage strong players in the paper converting industries to either expand or paper producers to forward integrate and seize the opportunities for growth, this has not actually happened due to the uncertainty from the flip flop tariff policy decisions.

Historically, the policy of "reservation" of this industry for the small scale sector has resulted in extreme fragmentation with low productivity, small capacities and poor quality of output. The indirect tax structure and the industry structure of consuming industries highlighted earlier allows these capacities to continue to exist albeit marginally and this production base continues to supply the existing demand, its survival being circumscribed by the tax/tariff structure applicable to users of packaging material.

During February 2008, corrugated box manufacturing was taken off the list of products reserved for the small scale industries. This change should see consolidation of production in the corrugated box industry as well as a significant shift in the overall quality of boxes. These changes would elevate the quality requirements for corrugating case paper - both liners and fluting, placing significant pressure on paper manufacturers in terms of fresh investments in paper making processes to meet the emerging quality requirements. New, better capitalized and organized players are expected to enter the market. However, the current tariff structure in the entire value chain from raw material for the paper industry to the final consumer product as well as the vertical value chain split described earlier will shape the speed of evolution and growth of this segment.

vi) Internal Control Systems:

Your company has an adequate internal control system in place. The internal control system is proactive. The company has an audit committee which oversees the adequacies of the internal control systems and reports to the Board.

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

Revenue from operations for the financial year 2020-21 increased to Rs 226.78 crores from Rs 217.61 crores from in the previous year.

National Lockdown, imposed to curb the spread of Covid-19 pandemic, towards the end of preceding financial year and continued restrictions impacted production and sales in first quarter of the FY 2020-21 to the extent of about 40%. Paper Division remained shut till 4th May 2020. Box Division resumed operations from 3rd April, 2020 as it was covered under Essential Services. After recommencing, initially both the units were operated with minimum possible employees, and subsequently scaling up gradually with necessary precautions and hygienic care and protection of the employees. The Company has adopted measures to curb the spread of infection in order to protect the health of its employees and ensure business continuity with minimal disruption. Operating levels improved and stabilized during the 2nd quarter and continued for rest of the year.

During the year raw material, fuel prices started moving up and the Company could recover the higher cost by improved realizations, which resulted in increase in top line.

Operation at the Paper Mill was lower @ 81% due to above factors happening in Q1 as against 86% of the Capacity during the preceding year,

At Printing & Packaging Division Conversion tonnage was about 5% lower, compared to preceding year.

Profit before interest, depreciation, tax (PBDIT) in FY 2020-21 was better on account of the above said factors at Rs 3,817 lacs from Rs 3,522 lacs in the preceding year. . Finance costs were higher at Rs 446 lacs from Rs 411 lakhs as the utilization of working capital facility, from bank increased. After making a depreciation provision of Rs 1,014 lacs (Previous year Rs 977 lacs), profit before Exceptional income & tax was Rs 2,357 lacs(Previous year Rs 2,133 lacs). Exceptional income of Rs 306 lakhs (previous year nil) on sale of part of an immovable property (held for sale), boosted the profit before tax to Rs 2,663 lakhs (previous year Rs 2,133 lakhs).

After making a provision for current tax of Rs 483 lakhs (Rs 372 lacs) & considering net effect of deferred tax & MAT credit charged of Rs 275 lacs (Rs 175 lacs in the previous year), net profit stood at Rs 1,905 lacs. (Previous Year Rs 1,595 lacs)

Key Financial Ratios

The Management had reviewed the changes in key financial ratios and have noted significant changes in all the ratios as niven below :

FY 2020-21 FY 2019-20 % change Remarks
Revenues from operation Rs in lakhs 22,678 21,761 4% Revenue increased in the Current year from 2nd Quarter in line with rise in realisations to offset the cost of raw material and other inputs, after reduced activity in Q1 caused by Lockdown imposed by Govt to combat the spread of Covid-19
Operating Profit Margin (%) (PBDIT) 16.83% 16.18% 4% Operating margins improved slightly on improved realisations and on recovery of the increased costs.
Net Profit Margin (%) (PAT) 8.40% 7.33% 15% Net profit increased on improved operating profits
Interest Coverage ratio (PBIT/Interest) in times (excluding interest capitalised) 6.28 6.19 1% due to increased earnings
Interest Coverage ratio (PBIT/Interest) in times (including interest capitalised) 5.28 6.19 -15% due to gradual drawal of Project Term Loan
Return on Networth ( PAT/ Equity) 12.34% 10.22% 21% due to increased profit
Debtors Turnover ratio (as a % of revenue) 20.53% 13.57% 51% Debtors level increased due to economic conditions & price rise
Inventory Turnover ratio (as a % of revenue) 12.96% 14.81% -12% Inventory level decreased slightly
Current Ratio 1.39 2.01 -31% mainly due to increase in short term borrowing;
Debt Equity ratio 0.42 0.17 147% Due to increase in Term loans drawn for the Project.

viii) Material developments in Human Resources/Industrial Relations front:

The industrial relations climate in the Company during the year was cordial and harmonius. A 6 year Wage settlement agreement signed with workers union at the Paper Mill will be in force upto 31-3-2022. In case of the Box unit, a 4 year Wage settlement agreement signed during the year with workers union is in force upto 31-3-2024.

The focus of HR activities is on employee involvement in operations of the company for effective results.

Efforts are being directed at building a strong management team oriented to entrepreneurial thinking and innovation in problem solving.

As on 31st March 2021, the Company had on its rolls, 363 employees consisting of 227 workmen and 136 technical/ supervisory/ Administrative staff in different locations.