Will Orient Paper & Ind.'s demerger plan help its business?

Reason behind the demerger

As per the OPIL's 2011 Annual Report, the cement business contributed 52% to its total revenues and 90.4% at the EBIT level. On the other hand, its core paper business has contributed 13.43% to the topline, and is currently under losses amounting to Rs 33.19 cr.  The electricals business has contributed 32% to the total business revenue, with 22% contribution to the operating profits.

The company's overall performance has been largely impacted by the paper and electricals business. The cement business has done well, but has been offset by the poor performance of the other 2 businesses. Therefore, the value created by the cement company was not reflected in the overall price of the company.

The paper business is not doing well as the sector itself is dealing with 3 major issues. One of the concerns is the availability of power which is facing problems due to the shortage of coal. Next is the availability of water. Water is required in huge quantities for the business, but is not available in the summer season, because of which the plant has to remain shut. Thirdly, pulp, which is the major raw material required to manufacture paper, is scarce, and only available at very high prices. 

The proposed demerger plan will create a focussed cement play for OPIL shareholders, and may elicit the expected value unlocking process. Apart from this, it will create a separate platform for each business to trace its own growth opportunities. Also, the demerger of the cement business into a new wholly-owned sub-Orient Cement will unlock the true value of the company.

If we look at the Q2 FY12 performance, the cement business has done well as compared to the other 2 businesses. The revenue of the cement business has grown by 57% on a YoY basis, whereas the paper business continues to remains under losses. The electricals business, which had a decent contribution in FY12, has shown disappointing figures that impacted the company's overall EBIT.

Therefore, we, at DSIJ, believe that with the demerger, the company will unlock the true value of the cement business, which is currently hidden by the 2 other businesses. We also think that the company should divest its paper business, as we don’t see any synergy between the paper and electricals businesses. This will further help the shareholders to unlock the true value of both the business on the basis of their own performance.