No respite on pa­per price

Ris­ing costs spell ra­tio­nal­i­sa­tion

Finweek English Edition - - Companies & Markets - SHAUN HAR­RIS

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.

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