Sappi: Positive signs, but everyone is not convinced
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
“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
“THE PAPER INDUSTRY IS STILL PLAGUED WITH EXCESS CAPACITY AND WITH CURRENT WEAK ECONOMIC CONDITIONS IN MOST MARKETS, PRICE INCREASES ARE DIFFICULT TO PUSH THROUGH.”
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
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