Beware Sappi’s ‘re­cov­ery’

There are many bet­ter in­vest­ments on the JSE

Finweek English Edition - - Creating wealth - LU­CAS DE LANGE

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.

SAPPI... MANY HEADACHES

SAPPI REL­A­TIVE TO JSE OVER­ALL

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