No respite on paper price
Rising costs spell rationalisation
SAPPI AND MONDI aren’t strictly comparable. Respective products and markets differ. Sappi is the world’s largest manufacturer of coated fine paper, typically used in producing glossy magazines. Mondi is big in the production of uncoated fine paper (office paper), bags and corrugated packaging.
Yet the two groups are South Africa’s paper and pulp industry and the only shares listed in the JSE’s paper sector. Both also have extensive global reach, throughout Europe, Asia and in the United States. Europe is the problem: an important market plagued by a lack of pricing power that is putting margins and profitability of all paper producers under pressure.
Sappi and Mondi have both committed substantial capital to operations in Europe. Currently, it seems Mondi might be getting it right, despite the tough market. The outlook for Sappi is less clear.
Reasonable interim results from Mondi showed the effect of Europe. A €39m “special item” – relating mainly to closure costs of a mill in Hungary – wiped 32% off pre-tax profit. “The cost is quite big. We closed a big mill in Hungary, involving retrenchment and other contractual costs,” says Mondi CE David Hathorn. Mondi’s capital spending has been aimed at expanding and upgrading mills in Russia and Poland. That’s where it seems to have the better strategy, spending on mills in lower cost Eastern Europe (where markets are also showing strong demand for paper). Logistically, transporting from emerging markets in Eastern Europe to clients in Western Europe is also not that expensive.
Mondi was unbundled from Anglo American and separately listed just over a year ago. It’s been showing its independence and with its unrelenting focus on cutting costs is perhaps less sentimental about dumping underperforming facilities, as it has done.
But last week Sappi showed it would also take action on underperformers, saying it was considering closing its Blackburn (England) mill and a paper machine at its Maastricht (Netherlands) mill. That, it said, was in response to “continued overcapacity in the European coated fine paper market” and the increased costs of raw materials and energy.
If both mills are closed, Sappi clients will receive products from other factories in Europe, but it will remove 190 000 t of fine paper production from Sappi’s annual capacity.
Sappi CE Ralph Boëttger highlighted those problems when third quarter results were reported a week ago. “Selling prices in Europe were flat quarter-on-quarter but declined from last year.” However, he said Sappi had announced price increases in Europe, effective 1 September, of between 8% and 10% “to offset the input cost price increases”.
That will be a big test for Sappi. Mondi tried to get price increases through in Europe earlier this year but they were rejected.
Boëttger is a relatively new CE and the possible closure of some Sappi mills underscores a point made by Allan Gray analyst and fund manager Delphine Govender. Writing in the asset manager’s latest quarterly commentary, she noted: “While betting on consolidation might ordinarily seem very brave, given the prolonged period of dismal returns for all players, the balance of probability now distinctly lies in this occurring sooner rather than later.
“One of the key supporting factors is that almost without exception the management teams at the helm of the various major European paper companies have been in place for less than three years. These newer teams tend to be less emotionally attached to assets (which they’ll need to rationalise/close) and also more impatient to see change.”
Allan Gray, while acknowledging Sappi’s inconsistent track record, believes recovery will be significant and consolidation in Europe will be the catalyst.
Mondi has been doing that; it now looks as if Sappi will too. And while Allan Gray likes Sappi, Deutsche Bank in France last week upgraded Mondi from hold to buy.
Mondi does seem to have the better strategy in Europe, despite slowing demand and pressure on pricing. Says Hathorn: “If you look at some of our big competitors, they’re losing money. Mondi is at least making decent money in Europe.”
Mondi is the more attractively rated share on the JSE, on lower earnings multiples and a more generous dividend yield than Sappi. But there’s a strange anomaly with Mondi. Also listed in London, there’s Mondi Ltd and Mondi plc shares on the JSE. Mondi plc is at a discount of around 20% to Mondi Ltd, and over the past year has lost more than 40% in value compared to Mondi Ltd’s 30% decline.
Dual listed shares on the JSE usually track prices closely. Any small gap soon disappears as an arbitrage opportunity. Not so with Mondi. One possible explanation is that institutional buyers view Mondi Ltd as an SA share and Mondi plc as an offshore one. Investment mandates could include one and not the other but it remains an unusual situation.