Orient Paper and Industries (NSE - ORIENTPPR) - Aug'12 Alpha plus special situation recommendation

1. Dear Members,
We would like to bring to your notice an interesting Special situation opportunity on
the 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 at
a gain of ~21%.
Earlier, we had to close the opportunity as the High Court approval was taking much
time. However, as per the latest details available with us, the company has received all
the approvals for the de-merger including the approval from the High Court and we
would therefore like to re-initiate the opportunity as the current valuations offer a
decent upside. The basic details on the opportunity are as below:
De-merger proposal
On 27
th
Ju’11, Orient Paper & Industries Ltd. (OPIL) announced that the Board of
Directors of the Company has decided to demerge the Cement Undertaking of the
company to a newly incorporated wholly owned subsidiary of the Company, namely
Orient Cement Ltd, through a scheme of arrangement, subject to approvals of the
Orissa High Court, shareholders and other regulatory approvals.
In consideration, Orient Cement will issue one equity share of Rs. 1/- each credited as
fully paid up to the shareholders of Orient Paper & Industries (OPIL) for each equity
share they hold in OPIL as of the record date, i.e. a demerger ratio of 1:1.

2. The Board of OPIL approved the demerger of the cement business with the following
objectives:
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 Stock
Exchange and the Bombay Stock Exchange. The company will issue fresh shares of
Orient Cement to shareholders of OPIL and therefore Orient Cement will have a mirror
shareholding as in OPIL.

3. Investment Rationale
Considering the operating performance of the company and the current valuations, we
believe the de-merger of the Cement unit will act as the much needed trigger for the
potential 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 a
50 MW captive power plant.
Cement industry being cyclical in nature; it is difficult to value cement stocks on the
basis of conventional methods. We would therefore use replacement cost approach.
Given the oversupply situation in the domestic cement sector and also with no
significant reforms in the end user segment around the corner, companies in the asset
based sectors like Cement tend to trade near their replacement cost or below. On the
contrary, an indication of expectation of pick up in volume or a sharp price increase in
the near term, takes the valuation of cement business above their replacement cost
maintaining a gap of premium between the companies.

4. 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 of
thermal power generation capacity.
Assuming Rs 600 crores/MTPA to be the replacement cost for cement plant and Rs 3
crores/MW of thermal power plant, we arrive at the following replacement cost for the
cement 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, Cement
unit of the company should alone be valued at ~ Rs 1900 crores while at current stock
price of Rs 64, the enterprise value (Market Cap + debt – Cash and cash equivalents) of
the 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 the
Paper unit of the company.
Electrical Unit:Orient is one of the leading brands in the Fans (Orient PSPO) and the
CFL segment. In order to capitalize on its brand pull and vast dealer network (more
than 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 has
recorded 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. As
per the industry standards and considering the strong pull for the brand , such

5. companies trade at a PE of 10, thus Electricals unit on a standalone basis can command
a market cap of 200 crore.
Paper Unit:OPIL has the largest Tissue paper capacity and the total Paper capacity at
100,000 tons per year, however for the last 3 years it’s been running at sub-optimal
capacity due to unprecedented water scarcity during summer months.
The Paper unit of the company has been recording operational losses. In order to arrest
the same, the company has already implemented corrective measures by investing in
creation 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 improve
the cost efficiencies of the paper and the chemical plant (36,000 TPA caustic chlorine
plant) and will result in annual savings of ~ Rs 30 crores.
Since the Paper unit is recording losses, we would assign conservative valuations of 200
crores, though the replacement cost of a 1 lakh ton Tissue paper plant, 55 MW power
plants, 36,000 TPA caustic chlorine plant could be much higher.
With conservative estimates, we arrive at a fair valuation of Rs 2300 crores against the
current enterprise value of Rs 1660 crores.
We believe, with the de-merger of Cement unit and independent listing as Orient
Cement Ltd, there’s a high probability of re-rating of the Cement unit of the company
with a likely listing at 60-65 per share.
As far as Paper and Electrical unit of the company are concerned, they will remain with
OPIL. Since losses of paper unit outweigh profits from electrical unit at the moment, the
stock is likely to quote at ~ Rs 15/- per share post the ex-date. However, during early
trading hours on ex-date, one might get a chance to sell OPIL at Rs 20/- or above and
thus create shares of Orient Cement at Rs 43-45 per share.

6. Investment and Profit booking Strategy
The company has received all the approvals including High Court approval (on 27
th
Jul’12). However, pending receipt of certified copy from the High Court, the company
has not yet announced on the exchanges.
From here on, it may take another 2-3 weeks at the maximum for the company to
announce the ex-date. In the wake of the same, we would like to suggest the following
allocation strategy:
Start with 4% portfolio allocation in the range of 62-65
Increase allocation to around 7-8% in case of a fall to 54-56
Profit booking:In case the stock approaches 72-74 before the ex-date, please book
complete profit.
While if it does not, then we should probably be able to sell OPIL on the ex-date at
around 15-20 per share in the early trading hours and retain the entitlement for the
shares of Orient Cement in the ratio of 1:1 at a cost of Rs 45/- per share. Orient Cement
is 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 Mittal
http://www.katalystwealth.com/
Ph.: 0120-4109766, Mob:[phone]
Email:[email protected]