Detailed Rationale

CRISIL Ratings' ratings on the bank facilities of Khanna Paper Mills Limited (KPM) continue to reflect the extensive experience of promoters, diversified product portfolio, strong clientele, and healthy financial risk profile. These strengths are partially offset by exposure to cyclicity in the paper industry and susceptibility to volatility in input prices.

 

CRISIL Ratings had assigned its 'CRISIL A/Stable/CRISIL A1' ratings to the bank facilities of KPM on 16th November 2022.

 

The ratings reflect the strong business risk profile of KPM, supported by the promoters' extensive experience in the paper industry, the company's diversified product portfolio (writing paper, board and newsprint), established dealer network and strong clientele - KPM has exclusive agreements with some key customers. Revenue was Rs 1,465 crore in the first half of fiscal 2023 and is expected to grow approximately 45% on-year and reach Rs 2,800-3,000 crore for the entire fiscal. The growth would be driven by continued robust demand in the newspaper print and writing and printing paper (WPP) segments owing to gradual reopening of educational institutions/offices, increase in utilization levels of the current capacity, volumetric growth and improved realization prices.

 

Operating profitability margin was 9.9% in the first half of fiscal 2023 and is expected to remain healthy at 10-11% over the medium term, driven by capital expenditure (capex) undertaken by the company for installation of the headbox, procurement of raw material through annual rate contract (ARC), improved product realization and upgrade of plant and machinery done in the past two fiscals. Operating margin had declined in FY22 to 4.41% (from 8-9% in past two fiscals) due to increase in raw material prices, freight charges (as company imports more than 60% of its raw material requirement) and increase in power and fuel cost. Besides, operating margins were also impacted due to excessive and uncompetitive procurement of wastepaper from Khanna Paper Inc (KPI; group company) which impacted the inventory pricing and hence margins. However, procurement of wastepaper from KPI has now reduced to around 15% in H1 FY23 vs 25% in FY22.

 

The rating also factors in the recent settlement and resolution among the promoters. The key promoter, Mr. BM Khanna, incorporated a trust between family members in October 2022 as part of family settlement for the equity shareholding held by them. Following the trust formation, Mr. BM Khanna would hold majority control in the business. After Mr. BM Khanna's exit, Mr. Rahul Khanna (principal beneficiary of the trust and elder son of Mr. BM Khanna) would get complete authority and hold all the strategic decision-making power related to the operations, treasury and day-to-day working of the company. Daily operations of KMP are run by both the promoters, Mr. BM Khanna and Mr. Rahul Khanna. Smooth transitioning of equity holdings and exit of Mr. Saurabh Khanna (younger son of Mr. BM Khanna) would remain key monitorable. Mr. Saurabh Khanna is expected to exit KPM next year and is currently holding directorship in a non-executive capacity. Formation of the trust should mitigate any shareholding-related issues over the medium term.

 

Financial risk profile of the company is strong marked by healthy net worth and gearing of Rs 552 Cr and 0.68 time respectively as on 31st March 2022, estimated at around Rs 650-700 Cr and ~0.5 time as of March 2023.  Liquidity will continue to remain strong over the medium term supported by net cash accruals of Rs 200-250 Cr sufficient to cater to its repayment obligations of Rs 65-75 Cr over the medium term and prudent working capital management. KPM has prepaid its principal repayment obligations till December 2022.

Analytical Approach

CRISIL Ratings has taken a standalone approach for assessing the business and financial risk profiles of KPM and has not consolidated the company with its wholly owned subsidiary Khanna Paper Inc (KPI) because KPI will get de-subsidiarized in the near to medium term, and all future transactions between KPM and KPI will take place at arm's length.

Key Rating Drivers & Detailed Description

Strengths:

Extensive experience of the promoters: The four-decade-long experience of the promoters, their strong understanding of the market dynamics and healthy relationships with customers and suppliers will continue to support the business. Daily operations of company have been managed by both Mr. BM Khanna and Mr. Rahul Khanna, managing director of the company. Revenue has grown steadily, supported by successful capacity enhancement and growing distribution network. Leveraging on the promoters' technical expertise, expansion of distribution network and operations at enhanced capacities have been stabilized. Revenue is expected to grow approximately 45% to Rs 2,800-3,000 crore in fiscal 2023, driven by volumetric growth and improved realization prices.

 

Diversified product portfolio catering to multiple end user industries and reputed clientele: KPM has a diversified product portfolio and is engaged in three product segments, namely writing and printing, newsprint and board. In fiscal 2023, the company derived 36% of its revenue through board paper, 36% through WPP and the remaining 28% through newsprint. Presence across multiple product segments aids steady demand in case of downturn in one segment. KPM caters to multiple end user industries, such as fast-moving consumer goods, footwear cartons, notebook covers, garments and apparels and liquor cartons, and supplies their products to reputed customers, such as Nestle India Ltd, Bennet Coleman & Co Ltd and HT Media Ltd. The diversified product portfolio and strong clientele will continue to support the business risk profile over the medium term.

 

Healthy financial risk profile: Financial risk profile is healthy on account of low dependence on external borrowings, adequate debt protection metrics and improving net worth year-on-year. Gearing was 0.68 time as on March 31, 2022, while net worth remained large at Rs 552 crore and is expected to increase to Rs 650-700 crore as on March 31, 2023. Despite planned debt-funded capex and moderate reliance on bank lines for meeting the incremental working capital requirement, the capital structure is expected to sustain over the medium term, supported by healthy accretion to reserve. Debt protection metrics were healthy, indicated by interest coverage and net cash accrual to total debt ratios of 3.24 times and 0.16 time, respectively, in fiscal 2022 and estimated at over 7 times and ~0.5 time in fiscal 2023.

 

Weakness:

Susceptibility to volatility in input prices: Operating margin declined to 4.41% in fiscal 2022 from 8.57% in fiscal 2021 because of increase in raw material prices, freight charges (as the company imports more than 60% of its raw material requirement) and rise in power and fuel cost per tonne. Besides, operating margin was impacted by excessive and uncompetitive procurement of wastepaper from KPI, which impacted the inventory pricing and, hence, the margin. However, procurement of wastepaper from KPI decreased to around 15% in the first half of fiscal 2023 from 25% in fiscal 2022. Moreover, being a non-integrated player, KPM is highly dependent upon procurement of imported wastepaper, unlike other leading players in the paper industry, thereby constraining its operating profitability levels and exposing it to associated risks, such as those related to foreign exchange and the supply chain.

 

In fiscal 2023, KPM recorded operating margin of 9.93% in the first half of fiscal 2023, supported by continuous improvement in realization prices, softening of raw material prices, upgrade of technology and substantial decline in procurement of raw material through KPI. The margin is expected to improve to 10-11% over the medium term, driven by capex being undertaken by the company for headbox, procurement of raw material through ARC (Annual rate contract), bottlenecking of process and refabrication of plant and machinery.

 

Exposure to cyclicality in the paper industry: Long gestation period in capacity addition and lead time in raw material generation, among other factors, make the paper industry inherently cyclical. Price of paper, which is a commoditized product, tends to fluctuate sharply and adversely affects the profitability of paper manufacturers. Demand for paper is also linked to the level of economic activity. Hence, cyclical downturns or adverse variability in the demand-supply balance may result in volatility in realizations. Furthermore, the risk of passing on increase in raw materials prices to end customers amid the demand supply dynamics will remain a key monitorable.

Liquidity: Strong

Net cash accrual, expected at Rs 200-250 crore per annum, will sufficiently cover the incremental working capital requirement and yearly debt obligation of Rs 65-75 crore over the medium term. Utilization averaged 68% for the fund-based limit and 91% for the non-fund-based limit over the 12 months through September 2022. Current ratio was 1.29 times as on 31st March 2022.

Outlook: Stable

The business risk profile of KPM will continue to benefit from its established market position, while the financial risk profile will remain strong.

Rating Sensitivity Factors

Upward factors

• Steady increase in revenue by 30%, driven by volume growth and operating margin sustaining at over 12%, leading to higher cash accrual
• Prudent working capital management leading to improvement in the financial risk profile, with gearing of less than 0.5 time

 

Downward factors

• Decline in profitability to below 7-8% or substantial fall in revenue leading to lower cash accrual
• Any unforeseen outflow of funds or emergence of family issues weakening the business risk profile or liquidity
• Large debt-funded capex or substantial increase in the working capital requirement weakening the financial risk profile, with gearing of more than 1.0 times

About the Company

KPM, incorporated in 1985 by Mr. Brij Mohan Khanna, manufactures quality WPP, newsprint and duplex-triplex board by recycling wastepaper. The company has four manufacturing units in Amritsar, Punjab, and a distribution network of over 150 dealers across India. Operations are managed by Mr. BM Khanna and Mr. Rahul Khanna.

Any other information: Not applicable