From paper giant to low cost fibre market leader
Sappi changed its focus to dissolving wood pulp, mostly sold to manufacturers of viscose, a semi-synthetic fibre, and other textiles.
IN 2009 THE share price of Sappi dropped from above R100 to below R20 a share. It was a difficult time for paper companies, with less spending on paper and more on digital. It was the pinnacle of the glossy paper slump and global overcapacity. Sappi made the bulk of its profit from graphic paper. For at least five years the share wobbled along below R50 per share. Nobody was interested.
Then Sappi changed its focus to dissolving wood pulp, mostly sold to manufacturers of viscose, a semi-synthetic fibre (a high-quality product that competes with cotton), and other textiles.
The pulp is also used in the manufacture of pharmaceuticals, cigarette filters, spectacle frames and cellophane. They mainly sell to manufacturers in Indonesia, China and India. Demand in the Chinese market is exceptionally healthy, and this year the average dollar price increased.
Earlier this year Sappi concluded a contract with Swedish Cellmark to deliver lignosulfonate, a by-product of pulp, which is used to make dirt roads less dusty and an additive to bind concrete mixtures. Growth was also experienced in its speciality packaging production. This division now accounts for 15 percent of revenue and Sappi intends to increase this to 25 percent by 2020. To cater for this market that grows at 3 to 4 percent per annum, Sappi has converted a mill in Europe, and two more mills in the USA and Netherlands are also being converted now.
Sappi managed to decrease net debt substantially over the last few years, according to the latest 3rd quarter results it stood at $1.31bn (R17.2bn) – $2.1bn in 2014. This generates huge savings on interest charges. And it is a great rand hedge; 49 percent of revenue is earned in Europe, 26 percent in North America and only 25 percent in South Africa. A movement of 10c on the rand/dollar exchange rate has an effect of approximately $3 million on profits.
Since 2015 profitability gained momentum and the tide changed. According to Sappi’s latest results, dissolving wood pulp accounts for 21 percent of revenue, but almost half of profits. There will always be room for paper, but this is not where the profits are.
Sappi currently produces 17 percent of the world’s dissolving wood supply, which is 1.3 million tons per year. They are now the world’s largest producer. The global demand is approximately 7 million tons per year, of which 60 percent is used in textiles. The expectation is that demand will increase more than 20 percent to 8.5 tons by 2020. Sappi intends to increase their production by 60 000 tons this year and aims to produce an additional 500 000 tons in five years. Phasing out low-margin speciality coated paper and the conversion to special packaging, where margins are more than double that of coated paper, will be another catalyst for growth.
Currently this is mostly used in the packaging of luxury items like perfume, but there is a lot of potential in the food packaging market, especially since plastics are considered toxic and being phased out by many food producers.
An investment in Sappi is not without risk, competition is fierce and many paper producers are converting to alternatives like cellulose pulp and specialised packaging. It is a capital-intensive business and expansion and conversions must lead to value-adding growth and efficiencies. A threat are higher raw material prices and a stronger rand. A higher oil price means higher energy costs and higher chemical prices, used in the production process.
Sappi is now one of the lowest cost producers in the world with the highest market share, and that gives them a head start. In May the share price reached R100 again, but recently came back to R85. A decent level to buy at, with the price-earnings ratio at 7.7.