There’s been activity in the global paper industry for some time now, but the pace has noticeably quickened lately. Newswires have been awash with announcements of strategy reviews, mill closures, redundancies and land sales.
Wherever you look on the world map of paper producers – International Paper (IP), UPM-Kymmene, Stora Enso, Domtar, Weyerhaeuser, MeadWestvaco, M-real, Arjo Wiggins – most companies are affected in one way or another. After years of struggling, the industry has started to grab the bull by its horns and reverse its ailing fortunes.
The investment community appears to like the sector too, clearly believing there’s money to be made here. After Madison Dearborn bought Boise Cascade back in 2004 or Koch Industries swooped for Georgia-Pacific last December, IP more recently sold its coated paper business to Apollo Management and sold over five million acres of its US forestland to two investor groups.
So are we in paper meltdown; is the industry as a whole in a state of permanent decline? It’s more about change than decline, it appears. And much of it is a result of high cost and overcapacity in the world’s developed markets, according to Dr Graham Moore of UK-based consultancy, testing and media business Pira International.
Moore says: "The paper industry has had a lot of mills for a long time and as such has plenty of operating facilities. As mergers and acquisitions have occurred over the past few years, the large remaining companies are seriously looking at their overall production base and this leads to many mills closing. This trend has been exacerbated in the last few months by high energy costs – it has simply become uneconomic for mills to remain open."
Moore cites Scotland as one particularly badly affected area in the UK where paper manufacturers (like Arjo Wiggins, for example) have downsized their facilities. But the same applies to other European as well as North American producers. In its Finnish homeland alone, UPM closed down several paper machines or even entire mills in 2004/2005 and several more are to follow over the next few months.
As Matti Lievonen, the company’s EVP for the fine and speciality papers division points out, UPM’s immediate focus is on the implementation of its profitability programme. He says: "Our aim is a return on equity of at least five percentage points above the yield of a risk-free investment such as the Finnish government’s 10-year euro-denominated bonds. At the end of 2005, the minimum target for return on equity was 8.2 percent. To ensure sufficient financial flexibility, the aim is to keep the gearing ratio well below the maximum acceptable level of 100 percent."
The US, meanwhile, has got its very own set of challenges. Traditionally a nation with low petroleum prices, high energy costs have sent freight charges sky-rocketing recently, to an extent where manufacturers cannot even supply their own – admittedly vast – country with paper products. This, of course, is exacerbated by the relatively small cost of the products themselves.
Another reason contributing to US companies’ financial woes is the legacies that firms have to their retired employees. Michael Negri is president/COO of Gould Office Paper, a division of global paper merchant Gould Paper Corporation.
He says: "The legacies that US companies have towards their retirees are just too rich. Many years ago, the unions negotiated with companies, wanting employees to ‘enjoy the fruits of their labour’ [resulting in what’s commonly known as final salary pension schemes]. At the time of course, life expectancy was much lower, about 70 years or so. Today, people live much longer."
US company pension schemes are currently undergoing a process of change, Negri adds, "because otherwise, they’re all going broke. Unless we do something, the expenditure is unbelievable especially as the baby boomer years are getting old now."
At the end of the day, it’s all about making money and the paper industry hasn’t made much of it in the last decade. In fact, the financial reports of most publicly listed paper manufacturers make for sobering reading.
Returning to profitability is also IP’s overall goal and is core to the company’s comprehensive strategy review. IP’s spokesperson Amy Sawyer says: "We’re not happy with the level of returns we’ve generated in the past and decided that we needed to focus IP on fewer businesses – those businesses where we’re well positioned and can win on a global basis."
IP is one of the few companies that have opted to sell huge amounts of its forestland – 90 percent of its total ownership in the US – in an effort to generate cash. The overall proceeds of these sales as well the divestments of some of its businesses – estimated to come to about $11 billion – will, according to Sawyer, be used to "a) pay down debt, b) return value to our shareowners, and c) selectively reinvest in our remaining global businesses, uncoated paper and packaging".
Sawyer adds that any reinvestments will take place both in North America and globally: "The key is not where, it’s the criteria we’re using. In North America, for example, our plan for now is to focus on fewer, bigger, better facilities while carefully managing our capacity to our customers’ needs."
And while overcapacity has been an industry eye sore for some time now, resulting in the closure of so many facilities, this should not be confused with a lack of demand, at least not on a worldwide basis. Senior analyst at Lehman Brothers, Peter Ruschmeier, pointed out at the 2006 PIMA Conference in Orlando last May that while US demand growth is indeed slowing, supply is contracting even faster. On a global basis, meanwhile, global trend demand growth exceeds supply growth.
So the paperless office remains a myth, but demand is clearly changing and manufacturers are reacting accordingly. Negri says: "Just five years ago, I must have been receiving anything between 400-500 faxes a day. Today, if I receive 50, that’s big. [In a nutshell], there’s overcapacity of economy grade paper, but what is happening is that much more quality or higher value papers are produced now – higher weight, higher brightness, paper for colour copying…
"All these product categories are expanding, probably not at the rate that mills would like, but they are expanding. And mills have begun to disengage from this economy-only interest. They’re closing facilities and are changing the way they do business."
Moore agrees that the more uneconomic paper grades – commodity grades like newsprint, packaging and office paper – are increasingly falling by the wayside.
That’s as far as the developed nations are concerned. Looking to emerging countries, the picture looks somewhat different. Indeed, slow growth, cost and overcapacity in the developed world have opened up new opportunities for international companies in emerging markets – eastern Europe, Russia, South America and Asia.
Brazil and Russia have long been favourite destinations among the big players as far as raw material sourcing and local manufacture is concerned. As much as 75 percent of fibre used for IP’s mills in the country comes from its own managed forests in Brazil and the company is currently exploring opportunities for another mill there.
In terms of sheer demand, however – as opposed to sourcing and manufacturing capability – China, rather predictably, wins hands down. The scope for a country that inhabits 25 percent of the planet’s entire population is staggering. Exports to the region are booming and Lehman Brothers’ Ruschmeier predicts that its paper industry could match that of the US by 2011 and become double its size by 2022.
From a manufacturing capability point of view, it’s early days yet. The majority of mills in the country are Chinese-owned and are mostly fulfilling local needs, but Moore believes this could change in the future because "they have the capacity and they certainly have state of the art paper machines".
And as China industrialises and its middle class grows, the demand for paper and paper products will grow exponentially and everybody having a foot in the door already will benefit hugely. Many global companies including Stora Enso and IP have set up joint ventures in the country, while UPM claims to have the "world’s biggest and fastest fine paper machine at its Chanshu paper mill".
The key issue for China – and the region at large, including India – is fibre accessibility as it’s very dependent on imports of raw material. Nearby Russia may have plenty of wood fibre, but its infrastructure as it stands now is far from satisfactory. So as the paper industry in China starts to explode, having a local presence and an international network of raw material sources, will aid the large globals no end.
As consolidation is gathering pace, the entire industry landscape is becoming almost unrecognisable as time goes on. Negri says: "By the end of this year people that have spent their lifetime in this industry will look at the line-up of companies in bewilderment. Just take the US market: we’ve got about five major paper mills left in the US that are in business papers – IP, Weyerhaeuser, Domtar, Madison Dearborn and Georgia-Pacific. I doubt that Koch Industries (owner of GP) even wanted the paper business, but that was the deal. But long-term and strategically, I don’t see GP in the white paper business, so if that goes, you’re talking about another million tonnes of paper not being here.
"As for Weyerhaeuser, there are rumours about the company spinning off its white papers group to either Madison Dearborn or Domtar or even IP. If that does happen, you’d be talking about the possibility of further closure, more people not in the business because of consolidation…"
So here we go again… it appears that for the paper industry, certainly as far as demand is concerned, all roads are leading to Asia, with some strong signposts to China and India.