Paper Market Forecast — Outlook Turns Bearish

BY MARK SMITH

Technology Editor

The end had to come sooner or later. Everyone knew the buyer's market for printing stocks simply couldn't last forever. Eventually, the adjustments made in papermaking capacity by suppliers and increasing demand fueled by the economic recovery had to bring price increases that stick.

Paper companies have announced or already implemented price hikes for most grades, and another round of increases may be in the offing before the end of the year. There's little reason to hope for a repeat of 2003, when increases were floated, but never fully implemented or were subsequently rolled back. Perhaps the clearest sign that market conditions have changed is the talk from some paper suppliers of instating allocation programs.

Before considering the evidence that supports the forecast of rising prices, there's a potentially more troubling wrinkle to the story that should be pointed out.

"It is highly unlikely that printers will be able to pass any increases in their costs onto clients," contends Andrew Paparozzi, vice president and chief economist at the National Association of Printing Leadership in Paramus, NJ. "That's because costs—including paper prices, labor and the like—are beginning to rise before we are seeing any rebound in pricing power."

Excess capacity and other competitive issues are keeping pressure on printing prices, even as demand and production volumes begin to grow, Paparozzi says. The current competitive environment will amplify the impact of any rise in costs, since extremely tight margins mean even modest increases can become very troublesome, he adds.

No Pass-along Increases

The economist believes printers will face a hard sell if they try to make the argument that, "My costs are going up, so I have to raise my prices." Even if they're shown a line-item increase on an invoice, he doesn't believe print customers will be receptive to price hikes for any reason.

Printers may have better luck if they prepare clients for the increases ahead of their implementation, Paparozzi suggests. However, he believes finding ways to offset rising costs may be the only effective response. "Printers need to continue improving their productivity and efficiency, even as business accelerates," the economist advises.

Paparozzi believes paper price increases will have staying power in the second half of the year because of the positive changes in the economy and business conditions. "In terms of the economy, what we're seeing is a rapid broadening of the expansion," he says. "A lot of sectors are now contributing to growth."

For the printing industry specifically, the middle of 2003 marked the beginning of a recovery, the economist points out. By late 2003 and into 2004, printing sales finally started to turn up.

"Sales were up 2.8 percent, year-over-year, for the three month period (December through February). That was the strongest growth we've seen over any three consecutive months since 2000," Paparozzi notes. While the final numbers were still being tallied, he says early data indicated that the positive trend would continue through April.

"What we haven't seen yet is a return of pricing power and profitability," the economist continues. "We may have at least hit a floor on pricing, though, as 63.7 percent of printers responding to our most recent survey said prices are increasing or at least holding steady. The improvement almost entirely came from printers saying prices are holding steady, but that's a start."

The more competitive the industry, the longer it takes to restore pricing power. Print markets used to be local or regional, and now they're becoming national and international as geographic borders are broken down by digitization and the Internet, Paparozzi explains. Competition also is coming from businesses providing an electronic alternative to print.

On the cost side of the equation, 23.3 percent of printers responding to NAPL's March survey reported paper prices were rising, as compared to 17.2 percent in January and only 9.7 percent in November 2003. "The good news is we haven't seen any signs of shortages," Paparozzi says.

Offering a similar take on current market trends is Ronnie H. Davis, Ph.D., chief economist at Printing Industries of America in Alexandria, VA. "With the economy back on a sound footing and print markets finally getting going, we will probably see some tightening in paper markets in the second half of the year," Davis says. "I expect to see some modest price increases and tighter availability, but no major shifts. Conditions are certainly improved, but not to the point of supporting major increases."

Davis believes the efforts of printers and paper suppliers toward creating a more efficient system has reduced the potential for wild price/availability swings. Also, imports should continue to dampen price pressure even though paper companies have worked to "restructure"—via mill closings and mergers and acquisitions—the supply side to bring it in line with demand, the PIA economist adds.

The results of this effort were quantified in the annual "Survey of Paper, Paperboard and Pulp Capacity" released earlier this year by the Washington, DC-based American Forest & Paper Association (AF&PA). According to the survey, U.S. paper and paperboard capacity declined annually from 2001 to 2003, and is expected to remain unchanged during the 2004 to 2006 period. Increased foreign competition, maturing domestic markets and competition from plastics and electronic media were cited as potential factors contributing to the lack of capacity growth.

Overall, capacity for printing/writing paper declined by 0.6 percent in 2003, AF&PA reports. Among the four major grades, only coated groundwood has registered an increase in capacity since 2000, growing by 2.6 percent.

Among the specific findings derived from the survey data were:

* Uncoated groundwood capacity fell to less than 1.9 million tons, or almost 20 percent below its 1996 peak level. Capacity for this grade is expected to rise about 2.3 percent in 2004, and then remain unchanged in 2005 and 2006.

* Capacity for coated groundwood dropped by 1.3 percent from its all-time high in 2002. The survey projects capacity to remain essentially unchanged through 2006.

* Coated free sheet capacity declined 4.2 percent from 2002 levels. Capacity is now 14.2 percent below its 2000 peak, and is expected to rise by 2.1 percent annually during the forecast period.

*n Uncoated free sheet capacity was the only printing/writing grade to show an increase between 2002 and 2003, to about 13.9 million tons. Capacity for this grade is expected to remain unchanged during the forecast period of 2004 to 2006.

The changing dynamics in the paper sector were nicely outlined in a recent presentation to the SC Council by industry analyst Verle Sutton of Forestweb, a Los Angeles-based provider of outsourced business intelligence solutions for the forest products industry.

The Shift Is On

Sutton contends that the market for SC printing papers is on the verge of shifting in the producer's favor, with higher prices likely to follow. He attributes this sea change to reduced supplier capacity, fewer European imports and stronger domestic demand. On that latter point, the Pulp and Paper Products Council (PPPC) reports that North American demand for SC-A papers increased by 12.8 percent in the first two month of 2004 alone.

Market conditions are ripe for a price increase, Sutton believes. SC-A prices are already on the way up, with the April increase of $40/ton expected to be implemented fully by July 1st. In addition, the market can expect a second increase in the third or fourth quarter, he says.

Providing further evidence were the $60/ton increases, to be effective June 1st, announced by several makers of coated free sheet and coated mechanical grades, the analyst adds. Various coated mills reportedly have been going on allocation recently, with order backlogs building for about the past month.

According to Forestweb, paper suppliers are taking advantage of firming demand due to improved economic conditions, as well as currency-related reductions in imports and increases in exports. Since there is no reason to expect those business dynamics to change in the near term, look for paper to be a seller's market throughout 2004.