Beware Sappi’s ‘recovery’
There are many better investments on the JSE
SOME OF THE best opportunities on the stock exchange occur when a heavyweight that has had some temporary problems enters a recovery phase after conditions turn back in its favour. That may be as a result of new management making necessary adjustments – often painful – or a cyclical growth phase that’s benefiting the entire sector.
One of the JSE’s big guns that recently received a great deal of that kind of attention is paper giant Sappi, which has been disappointing for so long. Since peaking at R162 in March 2002 its price fell by 64% to R58/share in May 2005 before starting to recover.
It’s now trading at about R107/share. The extent to which it’s been one of the back markers since 2002 is reflected by the relative strength graph, using the all-share index as base. Since 2002 it’s gone only downward, with a brief up-tick in mid-2004.
Unlike so many commodity shares it currently still cannot beat the all-share index. In fact, Sappi is performing worse with the 30week moving average having again turned downward, despite signs – according to its latest quarterly report – that profitability is improving. After certain accounting adjustments, earnings per share for the December quarter are put at 8c, compared with a 3c loss in the same quarter in the previous year.
In the September quarter, a loss of 16c was recorded – which means that for the first time since March 2005 it’s achieved positive earnings in two successive quarters.
Chairman and acting CEO Eugene van As said at the annual meeting earlier this month that an improvement in earnings is expected for the March quarter but that the price increases announced in Europe in December were hurting turnover. In any case, the increases aren’t enough to offset the cost inflation of raw materials and energy and further increases will be necessary.
What’s important is that the cash generated by operations remained sound despite the problems experienced by the group. Over the past two quarters it shot up to US$150m, as against $60m in the June quarter.
Apart from the fact that Sappi has to deal with difficult markets, there are also headaches concerning its top management. Van As, who was chief executive for 25 years before becoming non-executive chairman in 2003, had to take over last year after his successor, Jonathan Leslie, resigned unexpectedly. Van As has confirmed that nobody has as yet been found to replace Leslie.
Though the group is under pressure from stiff competition in the US and Europe, the real cause of some of Sappi’s problems must be sought elsewhere. For example, the pulp and paper industry has to contend with the emergence of electronic communication, such as email, which is replacing billions of letters and documents and continues to grow. But, fortunately, certain sectors aren’t affected: for instance, tissues and packaging materials.
Another aspect of the problems Sappi (and other large paper companies) faces is the cheap imports arriving increasingly in Europe and the US from Russia, China and South America. Morgan Stanley analyst Edings Thibault says that Brazil now produces the cheapest paper, thanks to its large plantations of, for example, rapidly growing eucalyptus trees.
At the same time China, which was traditionally a net importer of newsprint, has developed into a net exporter at highly competitive prices. Other countries in Asia, such as South Korea, are also showing strong growth in their exports of paper to the US at competitive prices.
In SA, Sappi’s forestry interests did well, with an operating profit of $78m (R587m), while its fine paper business broke even. Prices were increased by an average 9% in January. The group is currently involved in a $460m (R3,4bn) expansion programme at Saiccor, the world’s leading producer of chemical cellulose.
Private equity groups are showing an increasing interest in the industry.
So it’s a mixed picture. However, it’s clear that the restructuring of the pulp and paper industry – which includes closing mills – is far from over. Under Van As’s experienced leadership it’s expected that Sappi will be able to hold its own in the midst of turbulence in the industry. But not too much should be expected from an investment point of view. It’s simply an industry where things aren’t going well.
It should also be noted that private equity groups are showing an increasing interest in the industry – partly because of its strong ability to generate cash. (Van As declined to say whether private equity groups had approached Sappi.)
So there could be excitement. But if you’re looking for profit and growth potential, there are much better options on the JSE.