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.
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.