Paper Outlook — Cutting the Bottom Line

PRICE INCREASES, or attempts to implement them, are what’s on tap in the paper sector. Along with raising quoted prices per ton, paper companies could feel renewed pressure to pass along higher energy costs through surcharges if oil prices do climb toward the $100/barrel mark predicted in the most bearish outlook.

The Lane Press, in Burlington, VT, put an interesting spin on that latter market development. Under the “Did you know?” heading in its last two “Paper Prophet” newsletters, the printer pointed out to customers that “Lane Press’ close proximity to Northeast paper mills slashes transportation costs and reduces fuel surcharges.”

There hasn’t been any one big development in the paper sector this year, but a number of smaller forces are combining to move the marketplace. What’s having the greatest impact, though, is the longer term trend of globalization of the supply chain.

Volatile Markets

Globalization has the dual impact of making the paper market potentially more volatile, since it can be buffeted by a greater number of factors, but also dampens the ability of suppliers in any given region to drive pricing. Strikes, plant shutdowns and changes in demand that occur in one region can have a ripple effect on others. Broader economic issues, such as oil prices and exchange rates, also come into play.

Business trends in the North American printing industry, of course, still matter, but paper pricing in this region is now dependent on a large sphere of market drivers.

The outlook for printing volumes is turning more guarded, according to the latest “Printing Business Index” (PBI) report from the National Association for Printing Leadership in Paramus, NJ. This broad measure of print activity in the United States fell to 52.8 in June, its lowest level in three years. That compares to a PBI of 55.6 in May and 59.9 in March of this year.

The good news: a reading above 50.0 means more printers surveyed report activity is picking up rather than slowing down. It’s the downward trend that is troubling.

According to the report, recent PBI performance underscores the likelihood of major challenges ahead for graphic communications companies, despite brisk growth in current sales.

“Sales performance may suggest that business is good and there’s little to worry about. Unfortunately, that’s not the case,” cautions Joseph Vincenzino, NAPL senior economist. “Going forward, the economy will slow, and growing or even maintaining profits will get a lot more difficult. Companies must be prepared.”

In the “46th Annual Survey of Paper, Paperboard and Pulp Capacity” released earlier this year, the American Forest & Paper Association (AF&PA) reported that paper and paperboard capacity in the United States continued to edge lower in 2005, declining 0.8 percent. The survey estimates that paper and paperboard capacity will decline another 2.0 percent in 2006, then expand slightly in 2007 (up 0.2 percent) and 2008 (0.4 percent).

According to AF&PA, total capacity contracted 4.4 percent between 2000 and 2005, for an average annual decline of 0.9 percent.

Ongoing initiatives to bring production more in line with demand provided support for the largely successful attempts to boost paper prices in the first half of the year. Differences always exist among the various grades, of course.

Another round of price increases had been widely predicted for the third quarter of the year, coinciding with the normal cyclical uptick in demand. Stora Enso, NewPage and International Paper were among the companies to get in early with increases set for July 1st on coated freesheet or groundwood. More announcements of increases were expected, though generally anticipated to be modest.

Greater uncertainty was injected into expectations for the fourth quarter and beyond by the sudden flare-up of conflict between Israel and Lebanon (or at least its Hezbollah faction). Some stability had been returning to oil prices—albeit at an elevated level—as the world market adjusted to the level of tension in the Middle East. However, talk of Syria and Iran having played a part in the conflict at least opened the possibility of a wider conflict that could lead to energy price shocks.

Energy prices have become a key force cited by paper companies as driving the actions they have taken. One of the more dramatic examples was the reported appeal made by Stora Enso to the government of Nova Scotia for lower electricity rates, which it said was a condition for restarting production at its Port Hawkesbury paper mill. This announcement came on the heels of the company having finally reached an agreement with workers that was to end a months-old lockout.

That labor dispute is part of the trend toward increased union activity in the paper sector. Beginning in June, Sappi Fine Paper North America was operating under the threat of a strike after workers at two of its mills voted to authorize an action while those at two other mills voted against that move. This trend continues overseas, as well, with Finnish production having been temporarily shut down earlier this year due to a strike by the Finnish Paper Workers’ Union in protest against personnel reductions.

Internal forces still continue to reshape the North American paper industry despite years of restructuring. In the latest major deal, International Paper (IP) agreed to sell its coated and supercalendered papers business to CMP Holdings, an affiliate of Apollo Management L.P., for approximately $1.4 billion. This business unit operates four paper mills—in Jay, ME; Bucksport, ME; Quinnesec, MI; and Sartell, MN—and generated $1.6 billion in sales in 2005.

NewPage Corp., Dayton, OH, which was borne out of the sale of MeadWestvaco’s paper business in a deal financed by Cerberus Capital Management, floated and then indefinitely postponed an IPO (initial public offering) valued at $300 million. The company cited current “market conditions” as the reason.

Roughly a year after acquiring the Strathmore product line, Mohawk Fine Papers, Cohoes, NY, announced a formal relaunch of the brand. The company reports having done extensive market research that led it to create a portfolio of premium papers for a new generation of users.

Europe’s paper-making industry has started down the rightsizing path established in North America. The profit restoration program announced by UPM-Kymmene gives an indication of the scope of this effort. Through the closures, it reportedly intends to reduce 17 percent of its coated magazine paper capacity and 12 percent of its coated fine paper capacity in the region. According to Jussi Pesonen, president and CEO, this scaling back is necessary because “cost of production inputs have dramatically increased, and Asian and South American competition has entered the market.”

One other factor worth considering in assessing the outlook for paper in the fourth quarter is the impact of the postal rate increase that went into effect in January. Partly because the increase was expected for so long, print demand has held up despite this added cost. The last quarter is the real crunch time for budgets, though, so direct mail campaigns and holiday catalog mailings could still take a hit.

Looking ahead to 2007, the U.S. Postal Service has proposed an 8.5 percent rate increase that would likely take effect next May. Another big postage increase so soon is more likely to spur publishers, catalogers and direct mailers to switch to lighter weight grades, reduce page counts and trim sizes, and generally mail less, all of which impact the demand for paper. zz

Strikes, plant shutdowns and changes in demand that occur in one region can have a ripple effect on others.