Ripe for the pick­ing

An ex­pen­sive ac­qui­si­tion at the top of the mar­ket in 2008 sad­dled pa­per pro­ducer Sappi with huge debts, prompt­ing a suc­cess­ful repo­si­tion­ing of the busi­ness.

Finweek English Edition - - MARKET PLACE - Ed­i­to­rial@fin­ John Thomp­son is an eq­uity an­a­lyst at In­vestec As­set Man­age­ment.

with­the rise of the dig­i­tal age, it is hardly sur­pris­ing that the pa­per in­dus­try has been in struc­tural de­cline for many years. Quite a chal­lenge for a glossy pa­per pro­ducer like Sappi, but one that the com­pany has very suc­cess­fully man­aged to over­come, to such an ex­tent that we be­lieve it now of­fers a com­pelling in­vest­ment case for in­vestors.

The global fi­nan­cial crisis of 2008 could not have come at a worse time for Sappi. It had just ac­quired pa­per mills in Fin­land, Switzer­land and Ger­many from the M-real com­pany, and was not only buck­ling un­der a heav­ily in­debted bal­ance sheet, but op­er­at­ing in an en­vi­ron­ment in which growth – and thus de­mand – had ground to a halt.

The turn­around has been re­mark­able. Sappi dealt with the an­nual 3%-4% de­cline in pa­per vol­umes in the first in­stance by ag­gres­sively cut­ting costs, and in the sec­ond in­stance, by di­ver­si­fy­ing.

By mod­i­fy­ing some of their ex­ist­ing mills, Sappi in­creased their dis­solv­ing wood pulp (DWP) ca­pac­ity, or as it is known within Sappi, spe­cialised cel­lu­lose, by two-thirds. DWP is not made into pa­per, but once dis­solved can be spun into tex­tile fi­bres, specif­i­cally vis­cose sta­ple fi­bre, such as is used in the grow­ing trend for ac­tive wear. It can also be used in food­stuffs, house­hold prod­ucts and cig­a­rette fil­ters.

To­day, Sappi is the world’s largest man­u­fac­turer and seller of DWP, sup­ply­ing 17% of global de­mand. Rel­a­tive to its global peers, it is also a low-cost pro­ducer. Re­port­ing on its re­sults for the first quar­ter of the 2017 fi­nan­cial year in Fe­bru­ary, Sappi re­leased com­pelling num­bers for this di­vi­sion. DWP now con­trib­utes 62% to the over­all profit of the com­pany, with op­er­a­tion mar­gins high at 33%.

It should con­tinue to be a big driver of Sappi’s growth, as de­mand for DWP is grow­ing at 5% to 6% per an­num. In ad­di­tion, prices have been mov­ing up on tight global sup­ply, as sup­ply has been con­strained in cot­ton lin­ter pulp, the sub­sti­tute for DWP.

Mean­while, in Sappi’s tra­di­tional pa­per pro­duc­tion di­vi­sion, things have also been look­ing up. Pa­per still rep­re­sents more than 50% of group cash flow and man­age­ment con­tin­ues to tar­get ag­gres­sive cost re­duc­tions. How­ever, recog­nis­ing that de­mand for coated pa­per is likely to keep de­clin­ing, Sappi is di­ver­si­fy­ing into spe­cial­ity pack­ag­ing pa­per. In­deed, the com­pany an­nounced at its quar­terly re­sults pre­sen­ta­tion that it would in­vest ap­prox­i­mately $165m in North Amer­ica to up­grade a pa­per mill and $140m in Europe over a three­year pe­riod in a num­ber of projects to sup­port its spe­cial­ity pack­ag­ing pa­per ca­pac­ity. Once com­plete, Sappi should have more than 80% of its prof­its un­der­pinned by in­dus­tries with solid un­der­ly­ing growth fun­da­men­tals.

So there re­ally was some­thing to cel­e­brate in Jan­uary, when Sappi com­mem­o­rated its 80th year as a JSE-listed com­pany, as well as its re­turn to the bourse’s Top 40 In­dex, af­ter fall­ing off in 2009.

In con­clu­sion, we be­lieve Sappi to be in a bet­ter po­si­tion than it has been for decades and ripe for a rerat­ing. Re­turn gen­er­a­tion is at its best level in 50 years. Group mar­gins (on earn­ings be­fore in­ter­est and tax) are at their best lev­els in al­most 15 years and debt lev­els have come down ma­te­ri­ally, al­low­ing Sappi to de­clare its first div­i­dend since 2008.

In ad­di­tion, rel­a­tive to its global peers, Sappi is trad­ing at a value dis­count of be­tween 20% and 30%.

To­day, Sappi is the world’s largest man­u­fac­turer and seller of dis­solv­ing wood pulp, sup­ply­ing

A la­bel sits on a tim­ber log in a stor­age pile at Sappi’s Ngod­wana wood mill in Mpumalanga.

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