Orient Paper and Industries (NSE - ORIENTPPR) - Aug'12 Alpha plus special situation recommendation
Dear Members,We would like to bring to your notice an interesting Special situation opportunity onthe proposed de-merger of Orient Paper and Industries Ltd (NSE Code –ORIENTPPR).This opportunity was originally initiated in Jan’12 and subsequently closed in Mar’12 ata gain of ~21%.Earlier, we had to close the opportunity as the High Court approval was taking muchtime. However, as per the latest details available with us, the company has received allthe approvals for the de-merger including the approval from the High Court and wewould therefore like to re-initiate the opportunity as the current valuations offer adecent upside. The basic details on the opportunity are as below: De-merger proposalOn 27th Ju’11, Orient Paper & Industries Ltd. (OPIL) announced that the Board ofDirectors of the Company has decided to demerge the Cement Undertaking of thecompany to a newly incorporated wholly owned subsidiary of the Company, namelyOrient Cement Ltd, through a scheme of arrangement, subject to approvals of theOrissa High Court, shareholders and other regulatory approvals.In consideration, Orient Cement will issue one equity share of Rs. 1/- each credited asfully paid up to the shareholders of Orient Paper & Industries (OPIL) for each equityshare they hold in OPIL as of the record date, i.e. a demerger ratio of 1:1.
The Board of OPIL approved the demerger of the cement business with the followingobjectives: Creation of a pure-play cement company and to provide existing shareholders an opportunity to participate directly in the cement business. Enable both entities to explore various options to augment their growth plans. Sharpen management focus and assign greater accountability for each of the businesses. Unlock shareholder value as the demerger allows both companies to find their true value.Post implementation of the Scheme, Orient Cement will be listed on the National StockExchange and the Bombay Stock Exchange. The company will issue fresh shares ofOrient Cement to shareholders of OPIL and therefore Orient Cement will have a mirrorshareholding as in OPIL.
Investment RationaleConsidering the operating performance of the company and the current valuations, webelieve the de-merger of the Cement unit will act as the much needed trigger for thepotential value unlocking.OPIL has three business units: Cement, Electricals and Paper.Cement is the best performing unit of the company with the capacity of 5 MTPA and a50 MW captive power plant.Cement industry being cyclical in nature; it is difficult to value cement stocks on thebasis of conventional methods. We would therefore use replacement cost approach.Given the oversupply situation in the domestic cement sector and also with nosignificant reforms in the end user segment around the corner, companies in the assetbased sectors like Cement tend to trade near their replacement cost or below. On thecontrary, an indication of expectation of pick up in volume or a sharp price increase inthe near term, takes the valuation of cement business above their replacement costmaintaining a gap of premium between the companies.
As per the various reports, the current replacement cost of cement plant is around $120-125 per tonne. At Rs 50/$, it amounts to Rs 600 crores for installing 1 MTPA capacity.Further, it costs ~ 5 crore per MW of thermal power plant.Now, as at Mar’12 Orient had 5 MTPA cement manufacturing capacity and 50 MW ofthermal power generation capacity.Assuming Rs 600 crores/MTPA to be the replacement cost for cement plant and Rs 3crores/MW of thermal power plant, we arrive at the following replacement cost for thecement unit of OPIL:Cement Plant replacement cost: 600 * 5 = 3000 cr.Thermal Power plant replacement cost: 50 * 3 = 150 cr.Total Replacement cost: 3150 cr.Assigning a very conservative market valuation of 0.6 times replacement cost, Cementunit of the company should alone be valued at ~ Rs 1900 crores while at current stockprice of Rs 64, the enterprise value (Market Cap + debt – Cash and cash equivalents) ofthe company (inclusive of all three units) is Rs 1660 crores.Here it is important to note that we have not yet accounted for the Electricals and thePaper unit of the company.Electrical Unit: Orient is one of the leading brands in the Fans (Orient PSPO) and theCFL segment. In order to capitalize on its brand pull and vast dealer network (morethan 5000 dealers), the company recently diversified into small electrical appliances.Orient has registered over 30% growth year on year during the last 2 years and hasrecorded EBITDA margins of 8-10% on consistent basis, comparable to Bajaj Electricals,the industry leader.On a standalone basis, the Electricals unit can record a net profit of Rs 25-30 crore. Asper the industry standards and considering the strong pull for the brand , such
companies trade at a PE of 10, thus Electricals unit on a standalone basis can commanda market cap of 200 crore.Paper Unit: OPIL has the largest Tissue paper capacity and the total Paper capacity at100,000 tons per year, however for the last 3 years it’s been running at sub-optimalcapacity due to unprecedented water scarcity during summer months.The Paper unit of the company has been recording operational losses. In order to arrestthe same, the company has already implemented corrective measures by investing increation of 2 large water reservoirs with a capacity of 250 million gallons. Besides,company is in advanced stages of setting up a 55 MW power plant which will improvethe cost efficiencies of the paper and the chemical plant (36,000 TPA caustic chlorineplant) and will result in annual savings of ~ Rs 30 crores.Since the Paper unit is recording losses, we would assign conservative valuations of 200crores, though the replacement cost of a 1 lakh ton Tissue paper plant, 55 MW powerplants, 36,000 TPA caustic chlorine plant could be much higher.With conservative estimates, we arrive at a fair valuation of Rs 2300 crores against thecurrent enterprise value of Rs 1660 crores.We believe, with the de-merger of Cement unit and independent listing as OrientCement Ltd, there’s a high probability of re-rating of the Cement unit of the companywith a likely listing at 60-65 per share.As far as Paper and Electrical unit of the company are concerned, they will remain withOPIL. Since losses of paper unit outweigh profits from electrical unit at the moment, thestock is likely to quote at ~ Rs 15/- per share post the ex-date. However, during earlytrading hours on ex-date, one might get a chance to sell OPIL at Rs 20/- or above andthus create shares of Orient Cement at Rs 43-45 per share.
Investment and Profit booking StrategyThe company has received all the approvals including High Court approval (on 27thJul’12). However, pending receipt of certified copy from the High Court, the companyhas not yet announced on the exchanges.From here on, it may take another 2-3 weeks at the maximum for the company toannounce the ex-date. In the wake of the same, we would like to suggest the followingallocation strategy: Start with 4% portfolio allocation in the range of 62-65 Increase allocation to around 7-8% in case of a fall to 54-56Profit booking: In case the stock approaches 72-74 before the ex-date, please bookcomplete profit.While if it does not, then we should probably be able to sell OPIL on the ex-date ataround 15-20 per share in the early trading hours and retain the entitlement for theshares of Orient Cement in the ratio of 1:1 at a cost of Rs 45/- per share. Orient Cementis expected to list at Rs 60/- per share in 3-4 months.In case of any queries, please feel free to get back to us.Best Regards,Ekansh Mittalhttp://www.katalystwealth.com/Ph.: 0120-4109766, Mob: +91-9818866676Email: firstname.lastname@example.org