With major recovery elusive, mills focus on improving performance

Pulp & Paper, Aug 1999 by Jensen, Karl, DeKing, Noel, Routson, Joyce, Keaton, Diane, Et al

Unprecedented restructuring via mergers and mill closures is lowering costs as the industry tries to regroup after lackluster year

WITH LITTLE IMPROVEMENT EXPECTED on industry pricing in 1999, North American pulp and paper manufacturers are focused on improving operating efficiencies and managing mill operations. The resulting impact has been an unprecedented period of paper machine shutdowns, mill closures, and company mergers. Last December, Smurfit-Stone Container Corp. permanently removed over 1 million tons of production capacity in kraft linerboard and corrugating medium and since then a number of other companies have closed older mill operations that were no longer competitive. (Table 1)

To reduce the volatility in pulp and paper markets, companies have focused on consolidation. In two blockbuster mergers this year, International Paper Co. (IP) acquired rival Union Camp Corp. for $7.9 billion and Weyerhaeuser Co. announced a takeover of MacMillan Bloedel Ltd., Canada's largest paper and forest products group.This follows last year's $2.5 billion merger of Avenor Inc. and Bowater Inc., creating the second largest newsprint manufacturer in North America.

Until recently, the paper and forest products industry appeared to be as focused on construction of new mills as it was on earnings and shareholder value. But the significant cost advantages of building new papermaking capacity in Asia and South America has changed the business environment forever. There is also motivation toward further consolidation because the U.S. is no longer a low-cost producer of paper products.With mergers, the potential for cutting costs is substantial. For example, since the former AbitibiPrice Inc. and Stone Consolidated Corp. merged in 1998, the successor company has reduced costs by over $200 million. Merging with Union Camp is expected to create $425 million in savings for IP "For the first time in the recent history of the industry, aggregate capital spending will be below depreciation levels," commented John Linehan, an investment analyst at T. Rowe Price Associates.

Companies are purchasing paper mill assets rather than building new greenfield operations, a trend which has been pushed by Wall Street observers for years. "I think it's vital for this industry," said William Wigder, managing director of equity research at Credit Suisse First Boston Corp.

Moving into the second half of 1999, few pulp and paper companies will see big gains in revenue or net income. Commodity pulp and paper prices remain depressed worldwide and North American manufacturers have seen their share of international markets declining. This means careful management of mill capacity and an eye on operating costs.

George Mead, chairman of Consolidated Papers Inc. in Wisconsin, summarized the outlook for the remainder of the year. "We expect that the focus on our core business of coated paper, our cost-cutting measures, our continuing investment in technology, reduced capital spending, new product development, strengthened sales organization, and our loyal, hard working employees will help bring us through this temporary downturn."

PULP INDUSTRY SEES A BRIGHTER FUTURE. The market pulp industry is showing signs of sustainable recovery for the first time since the market collapsed in early 1996 Prices began turning upward in April 1999, reaching $520/mton in Europe for benchmark northern bleached softwood kraft (NBSK), and are likely to maintain their levels throughout the summer. This momentum could enable producers to seek modest increases in the fall, setting the stage for NBSK to reach as high as $650/mton by the end of 2000.

Despite the rosier picture, the pulp industry, as a whole, is not yet profitable. Some NBSK producers need $500/mton just to break even.The first-quarter price in Europe was only $460/mton and the June 1999 price of NBSK is still 9.6% below that of June 1998 and 7.1% below that of June 1997. In fact, the price is virtually the same as it was in June 1996, just a few months after it collapsed to $480 to $500/mton. In the three years since, prices have reached as high as $610/mton. But that, too, is a far cry from the price of nearly $1,000/mton during the almost two-year run-up that ended in fourth-quarter 1995.

Nevertheless, demand is improving worldwide, particularly in the key regions of Europe and Asia (except for Japan). A 1999 report by North American and Nordic (Norscan) and Brazilian industry associations forecasts demand to grow by an average of 2.5% per year in the period 1999 to 2001-a marked improvement from 1998, which saw a 1.4% decline. Because of seasonal slowdowns in Western Europe, which accounts for 45% of world demand, summer is traditionally a tenuous time for pulp pricing. In contrast to other recent years, however, European papermakers are not extending their typical summer shuts in 1999, so pulp buying is continuing at expected levels.

The other immediate good news for producers is from Asia, where demand has been picking up for some months now as the region recovers from the financial crisis that began in mid-1997 and sent the pulp industry into a tailspin. Non-Japan Asia/Africa accounts for nearly 20% of world demand and suppliers depend on the region to take incremental tonnage. Producers are also encouraged by the prospect of smaller-than-usual increases in global market pulp capacity, coupled with the improved demand. The report forecasts that the demand-to-capacity ratio, down to 88% in 1998 from 91% in 1997, will rise to 91% in 1999 and 2000 and to 93% in 2001.