Sappi: Pos­i­tive signs, but ev­ery­one is not con­vinced

Finweek English Edition - - INSIDE - BY SHOKS MZOLO

Steve Bin­nie, at the helm of Sappi for the past 10 months, has had a tough shift. The pa­per­maker’s for­tunes abroad, where Sappi de­rives 75% of its sales, are wan­ing due to fall­ing de­mand and sub­dued prices for pa­per. Added to this is a net debt of $2bn ( R24bn), due in part to the $1.1bn ( R13bn) buy­out of M-Real’s graphic pa­pers busi­ness in 2008, which is putting its bal­ance sheet and cash f low un­der pres­sure, leav­ing it with lit­tle room to in­vest in higher growth op­por­tu­ni­ties.

Re­duc­ing the com­pany’s debt re­mains Sappi’s “num­ber one pri­or­ity”, says Bin­nie. Re­sults for the first quar­ter ended De­cem­ber showed a re­duc­tion in net debt of $ 340m (R4.1bn), while net f inance costs for the quar­ter to­talled $52m (R630m). The group is tar­get­ing a net debt– to-EBITDA (earn­ings be­fore in­ter­est, taxes, de­pre­ci­a­tion and amor­ti­sa­tion) ra­tio of 2 times (it cur­rently ex­ceeds 3), al­low­ing for mod­er­ate in­vest­ments in growth no later than 2018, while a l so t a ming t he cost of debt and re­duc­ing the risk to the busi­ness of

be­ing geared.

“Just to be clear, Sappi has not strug­gled to ser­vice its debt,” he says.

Un­der Bin­nie, who joined Sappi from Ed­con in 2012 to take over as chief f inan­cial off icer, the group has fo­cused on cost-cut­ting, the clo­sure of loss-mak­ing op­er­a­tions, strength­en­ing the bal­ance sheet through im­proved work­ing capita l man­age­ment, t he


sale of non-core as­sets and re­duc­ing debt, and grow­ing the con­tri­bu­tion f rom ad­ja­cent busi­nesses such as spe­cialised cel­lu­lose, pack­ag­ing and com­ple­men­tary industrial prod­ucts.

While cash is tight, the group con­tin­ues to in­vest in some ef­fi­cien­cy­im­prov­ing ven­tures. A new power plant, at Kirkniemi Mill in Fin­land, ex­pected to be op­er­a­tional in early 2016, will sig­nif icantly im­prove cost com­pet­i­tive­ness and prof­itabil­ity by re­duc­ing en­ergy costs and se­cur­ing en­ergy sup­ply, Sappi says. The plant can po­ten­tially use 100% solid biomass such as bark from the mill’s de­bark­ing process.

Sappi is also busy with an up­grade to t he pulp pro­duc­tion fa­cil­i­ties and pa­per­mak­ing ca­pa­bil­i­ties of its Gratkorn Millin Aus­tria, which is ex­pected to be com­pleted by the mid­dle of the year. This will se­cure a sig­nif­i­cantly lower cost base and also en­sure long-term com­pli­ance with emis­sion lim­its, it says.

De­spite t he pos­i­tive signs, not ever yone i s con­vinced yet. Ab­dul Davids, head of re­search at Kag­iso As­set Man­age­ment, says that de­spite “the re­newed fo­cus, Sappi does not gen­er­ate enough cash f lows to pay down its debt”. He ex­pects its fo­cus on its spe­cialised cel­lu­lose op­er­a­tions, which con­trib­uted 48% to EBITDA in the De­cem­ber quar­ter, ex­clud­ing spe­cial items, to help t urn the ship around.

How­ever, Sappi re­mains overly e x posed to what i s ad­mit­tedly a decl i ning s ec­tor: pa­per. Graphic pa­per mar­kets re­main chal­leng­ing, Sappi says, al t hough it ap­peared “marginally bet­ter” t han ex­pected in North Amer­ica and Europe, with de­mand de­clin­ing at lower rates than fore­cast. The group earns 81% of its sales from pa­per, with coated pa­per (with 59%) con­tribut­ing by far the largest pro­por­tion to over­all rev­enue. (Spe­cialised cel­lu­lose, which is sold to con­vert­ers for a wide range of con­sumer prod­ucts, no­tably the man­u­fac­ture of vis­cose sta­ple f ibre for cloth­ing and tex­tiles, ac­counts for 18%.)

In North Amer­ica, which ac­counts for 25% of group sales, prices for fine pa­per were up marginally in the first quar­ter to $1 060 (R12 857) a ton – from $1 049 (R12 723) a year ear­lier – while costs in­creased slightly to $1 072 (R13 002) a ton – Q1 2014: $1 057 (R12 820). Europe, by far its most im­por­tant mar­ket, ac­count­ing for 50% of group sales, saw tons sold decline by 7.3% year-on-year in the De­cem­ber quar­ter, while prices and costs were al­most un­changed at €706 (R9 276) and €690 (R9 066) a ton re­spec­tively.

“The pa­per in­dus­try is still plagued with ex­cess ca­pac­ity and with cur­rent weak eco­nomic con­di­tions in most mar­kets, price in­creases are diff icult to push through,” Davids says.

Ques­tions also re­main about Sappi’s M-Real deal. Given con­sis­tent signs that pa­per was set for tough times, just what mo­ti­vated Sappi to pur­sue a loss­mak­ing M-Real’s mills, in Fin­land, with a €750m (R9.8bn) price tag? This has never been quite clear. It has since closed the Biberist Mill in Switzer­land and will shut t he Kan­gas Mill i n Fin­land in June, which will leave only t wo of the four mills ac­quired in the

deal op­er­a­tional.

Look­ing at the up­side, Bin­nie says that M-Real has dou­bled Sappi’s size in Europe. This, he adds, en­abled the f irm to con­sol­i­date its port­fo­lio and to drive its strat­egy of “be­ing the low­est cost pro­ducer in its mar­ket seg­ments”. Sappi Europe also re­mains a ma­jor cash f low gen­er­a­tor for the group.

While Sappi’s share price is up 46% over the past year to just over R50 a share at the time of go­ing to press, it is cold com­fort for long-time in­vestors in the stock. It traded at R100 a share a decade ago and R80 at the time of the M-Real deal in 2008. While Sappi has halved in value over the past decade, the JSE’s All Share In­dex has tre­bled.

In con­trast, Mondi, Sappi’s ma­jor ri­val, has al­most quadru­pled in value since its l ist­ing, fol­low­ing its 2007 un­bundling from An­glo Amer­i­can. The group has trans­formed from a high- cost pa­per a nd pack­ag­ing busi­ness to a fo­cused industrial and con­sumer pack­ag­ing busi­ness with low-cost op­er­a­tions in Eastern Europe (a switch from South Africa and West­ern Europe), Davids says.

Mondi (see side­bar), which “has been very ac­tive in closing its un­prof it able op­er­a­tions”, has the flex­i­bil­ity to in­crease pro­duc­tion at its other prof itable op­er­a­tions to off­set the clo­sure of un­der­per­form­ing plants, says Davids. The com­pany said that it will close its loss-mak­ing mill in Lo­hja, Fin­land, in June.

Sappi’s Ngod­wana wood mill in Mpumalanga

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