How the CFO Is Managing a Spending Spree

“There is no business reason for us to go outside,” says V. Kumaraswamy, CFO of JK Paper, India’s largest paper company in sales. “India is the best-performing paper market in the world today.”

The country’s paper industry is so vibrant – 8.8% annual growth, JK Paper says, compared with 2.1% globally – that the company is spending the equivalent of its annual sales of US$350-US$400 million on expanding its paper mill in Orissa state. 
Kumaraswamy (pictured) recently raised €35 million from foreign currency convertible bonds (FCCBs) issued to a consortium of Dutch, French and German development financial institutions, and an additional Rs2.5 billion (US$49.5 million) from a rights issue and Rs10.3 billion (US$204 million) in term loans.
He spoke to CFO Innovation’s Bina Jang about managing the expansion and other challenges facing JK Paper.
To what extent has the global economic slowdown prompted JK Paper to refocus on India rather than on exports?
We export only because of choice – only 5% [of gross sales] – just to get customer feedback from advanced markets on our various products. India is the best-performing paper market in the world today . . . There is no business reason for us to go outside.
Having said that, the rupee has depreciated recently, from Rs44-to-US$1 to Rs49 a depreciation of about 10% – so that gives us an opportunity to push a little more in markets in which we are already established.
India’s economic growth is slowing, though, and you have issues like rising inflation, labour costs and raw materials, and a volatile currency.
The main problem for us is coal supply. The government has a monopoly and increased prices sharply in March 2011. The supply is also not as forthcoming as growth in demand, making us rely more and more on market coal [sourced from the local open market, rather than government supply] and imported coal, which is priced almost two to two-and-a-half times higher than the government supply.
What about raw materials?
For us this is wood, supplied by private farmers. Supplies did grow sharply during 2008-2009 and 2009-2010, but growth rates in 2010-2011 have moderated considerably.
[The reason is that] in 2008-2009 and 2009-2010, the government had a programme of Minimum Support Prices (MSPs) for crops, not including trees. If you give [greater] returns to alternative crops, people have a tendency to switch to those crops. So unless tree plantations yield [the same kind of] returns people are unwilling to stay with tree growing.
There is a lag effect of 12-18 months, and that is why [wood] prices were pushing up in the last 24 months.
The currency is an issue as well?
In our case, the US dollar [is used in] 80-85% of our imports and exports. Whether or not you are importing or exporting, however, [currency volatility] has started affecting domestic companies by way of price. If import parity prices are low, obviously people will import rather than buy from domestic players. So it has become a headache for everybody.
For us, we import pulp for our packaging board operations, and that is US$1.5 million to US$2 million per month; and to the extent that we export, that is about US$1 million, so we have to watch [currency movements].
More importantly, we have announced a  large expansion [of our paper mill in Orissa state], in which the import component [for equipment] is almost €110 million. We have tied up loans of an equal amount from outside. So the management of these [loans and capital investment] is a priority for us right now.
That must take some doing, given the volatility in foreign exchange movements.
The market has been kind to us.
Currency rates have gone up significantly compared with when we conceived the project [and decided] what rates to use. If you look at the swap rates and forward-exchange rates in terms of implied cost of interest percentages, it was almost 9.5% nearing 10% when we were planning [the Orissa project]. I am talking of fully hedged costs – even if we don’t pay, I cost it.
Today, the currency has moved up, but the interest swap rates and currency swap rates have come down sharply, with the result that even if I pay the additional value of the dollar, it will be amortized over the tenure of the loan. Taking all that into account, the hedged cost comes to about 8%, so I [save] almost 2% over ten years, which far outweighs any currency movements there may be.
Second, we have some strict policies on hedging, whereby the benchmark rate – the rate at which we could have taken an alternative action – is fixed at the beginning. We need to cover our positions before we cross that limit, so that at least a portion of the gains by borrowing from  abroad [for capital] is retained.
So interest rates have not really hit us as much as would have been expected. Indian interest rates have gone up sharply, from 9% to 12% in the last 12 months, but for people borrowing abroad they have not gone up as much.
Besides the Orissa mill, is JK Paper expanding elsewhere in India and abroad?
This expansion is [already] fairly big in relation to the current size of company. We are a US$350-400 million company undertaking an expansion of almost the same size. The project will take another 12 months to complete.
Meanwhile we have drawn up plans for looking ahead that are being proposed and fine-tuned. The general direction is that India is running short of wood resources, the basic raw material for the paper industry, and we have started looking at wood resources outside.
We have started [looking at] six to seven countries. One or two have already reached the evaluation stage and we are preparing feasibility studies.
Let me ask you about IFRS, which India committed to adopt from 1 April this year. How is this affecting JK Paper's financial reporting?
IFRS has not yet become mandated in India. The government has not yet announced the firm dates. Although we had completed the exercise to start IFRS from April 1 this year, we had to abandon it because the cut-off date for change of valuation was not notified.
In terms of preparedness, as and when the government announces [the cut-off date], we will take a month or a month and a half to get [IFRS reporting] started.
However, we have evaluated the impact on us and concluded that it will not be very much in terms of our revenue practices, because the Indian government also has been slowly progressing towards accounting standards, in instalments if not wholesale. The only difference, if at all, will come in valuation of property, plant and equipment.
We do not expect significant disturbances either in implementation, or due to implementation, in the financial results announced.
In the latest round of FCCBs, we have paid the entire [amount] as coupon every year. We’re also booking it every year, so [IFRS valuation] doesn’t really affect us in that sense, whereas companies that have been booking only the small interest coupon portion would have been hit.
About the Author
Bina Jang is a Contributing Editor at CFO Innovation.

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