New Capacity, New Valuation
It’s kind of boring business but less technology disruptive risk as many industry has experienced in this era.
- Investment Thesis
- The company has fulfilled prior capacity of 300 tons a day since 20 years ago this is the main reason why revenue is flat. After feasibility study, UTP decided to expand new capacity for 500 tons a day which is now both machines are online.
- Gross Profit Margin Improvement : from my point of view, UTP will benefit from Economies of scale when two machine can run altogether and the analysts on the market only assume normal Gross Profit Margin without take into account the benefit of Economies of Scale. Normal GPM is approximately 15% but I think it can increase to 17-18% given material cost hasn’t changed significantly due to incremental fixed cost will be compensated by a larger of incremental sale.
- Tax Benefit : New machine is under BOI agreement which is Tax free for 8 years this also make bottom line more gorgeous.
- Business Overview
- UTP is kraft liner board and corrugating medium manufacturer.
- Kraft liner board is made of long-fiber pulp and short-fiber pulp in order to strengthen the packaging and there are many grades of kraft liner board such as KA, KJ, KP, KX level which distinguishes by usage, thickness and strength.
- Corrugating Medium is made of OCC (Old Corrugating Container). Thai paper mills mostly import from Japan, US, Australia and Europe.
- Kraft liner has better margin than corrugating medium.
- Product mix, Kraft liner : Corrugating medium = 40:60
- Revenue Structure
- Type of Customers : There are only 11 customers in portfolio which compose of roughly 60% is related party order (order from shareholders) and 27% from major customers. In 2016, There is only one customer in Vietnam that UTP export to. Domestic sale has better margin than export sale. This may consider as concentration risk in business operation. For the last 5 years, the company has no problems of losing significant customers.
- New Capacity Expansion
- In the past, UTP has only one machine in paper mill that located in Prachinburi (Thailand) with total capacity of 300 tons per day which always operate at maximum level for 24/7. One shortcoming of one single machine in factory is wasted time of switching production line from thin grade to thick grade and vice versa.
- UTP decided to expand their capacity from 300 tons/day to 800 tons/day by establishing new machine (500 tons/day) from China and Co-generation power plant 12mkw in order to supply energy both steam and electricity directly to new machine with cheaper cost compare to purchasing from Provincial Electricity Authority (PEA) and UTP must have new water treatment system to comply with environmental agreement.
- Total investment is 1,650 million baht that consist of
- Machine : 1,200 million baht (Depreciable life 15 years)
- Water Treatment system and Building : 450 million baht (Depreciable life 10 years)
- Source of fund
- Where is the new order come from?
- Management team has targeted total order in 2018 to 264,000 tons (720 tons per day).
- According to prior revenue structure, Order from related group (U-Group) has 60% contribution which turn into volume base for 200 tons/day account for 66% of U-Group usage. Therefore, U-Group will increase their demand up to 300-330 tons/day in order to shift residual demand from others to UTP.
- Major customers are account for 30% of total revenue, 100-120 tons per day in term of volume. They’re interesting to shift order from other paper mills to UTP in order to gain discount benefit from large ordering. Investor relation claims that those customers are seeking for more credit line with the company due to additional order in the next yer. This potential orders might increase to 200-250 tons per day.
- Where the rest of volume come from? – UTP will start to find new customers both in domestic area and export market according to Investor relation seems confident that 20,000 tons per month or 666 tons per day is possible and most of it is already committed.
- But in order to ramp up production to 700 tons per day, UTP has to fine tune and learn how to use high frequency production line of new machine that workers are not familiar with before. This concern will be addressed by hiring expert from Taiwan who experienced in paper mill production to manage at full capacity production.
- Industry outlook
- Domestic Industry.
- This sunset industry has been dominated by SCG for 40% of market share in 2015 and Panjapol group (Hiang Seng and Panjapol Pulp) has 24% market share. I think this industry is already consolidated. There are many acquisition in the past like Thai Cane paper and SCG. Today, major players has less intention to start price war again to hurt the whole industry due to they are in Thai Pulp and Paper Industries Association (TPPIA) that govern paper industry in Thailand which made this market is less competitive than the past.
- According to Data from The Office of Industrial Economics, It shows that domestic production is not sufficient to serve domestic sale so the oversupply as most people said is from import.
- Let’s take a look closer on monthly period we will see the risen of selling price due to raw material such as paper pulp and OCC price are increasing because of surging demand in china after the closure of paper mill in China because of environmental issues and China government ban 24 type of solid waste imports and another factor is booming of e-commerce in recent period. While other commodity company has less bargaining power to raise price but UTP has adjusted price up for 3 times since the beginning of 2017.
- Update (28-Sep-2017) China ban on waste imports leads to piles of paper abroad, surging prices in China. After china ban OCC and waste paper import into country which force waste paper and OCC exporters to find new market like South East Asia and Europe to compensate these orders. This lead to even higher of both cost and selling price of cardboard in China in the future. (Source: https://www.cnbc.com/2017/09/28/reuters-america-china-ban-on-waste-imports-leads-to-piles-of-paper-abroad-surging-prices-in-china.html)
- Ending inventory of Kraft paper in 8m17 declined by 16% compared to 8m16 from 1.23 million tons to 1.035 million tons in 2017.
- Export data shows a significant surge in 2q17 and 3q17 increased by 58% and 77% yoy, respectively.
- Kraft paper industry is growing along with domestic economic growth.
- Domestic Industry.
- Gross Profit Margin Improvement
- As gross profit margin that presented in 2 latest quarters decreased to 14% mostly due to higher of human cost and depreciation of new machine while UTP shut down old machine for maintenance and UTP will smoothly run 2 machines altogether in October 2017 which incremental sale will increase more rapid pace than fixed cost. I believe that UTP can reach 17-18% of Gross profit margin in 4q17 given no significant higher price of raw material relative to 1H2017.
- Administration cost didn’t increase significantly due to frugal philosophy of management.
- Even 60% of customer is related party (U-group), gross profit margin is not drastically low compared to the largest paper mill in china “Nine Dragons Paper Holding LTD.
- Healthy Cash flow and Balance sheet
- UTP produces EBITDA and Operating Cash Flow each year before new capacity approximately 350-400 million baht and 300 million baht, respectively. Total Interest Bearing Debt as of 2q17 to EBITDA is 3.2 times (960 IBD/300 EBITDA). As a result, there is no problems on servicing debt or interest payment.
- After this huge capital expenditure, There will be no major capex until the next capacity expansion and maintenance cost is roughly 20-50 million baht each year.
- Unable to fill up capacity as expected
- Cost overrun
- Risk of losing customers
- Oversupply from Vietnam
- In the past, Vietnam has 6-7% of economic growth which boosting domestic consumption that made increasing of Kraft paper packaging demand and the capacity of paper mill in Vietnam is not capable to serve the whole country. There will be new capacity expansion that will operate in 2017-2018 for 1.4 million tons while supply deficit in 2015 was 1 million tons. (Source : http://www.paper-vietnam.com/news/detail/vietnam-paper-industry-overview-201/)
Ticker : UTP
Market Cap. : 5,850 Million Baht
Outstanding Shares : 650 million shares