Financial Mail - Investors Monthly - - Contents - Stafford Thomas

Sappi, ENX, Northam, Hyprop, Emira Prop­erty Fund

It takes nerve to em­bark on the rad­i­cal repo­si­tion­ing of a busi­ness. Sappi did just that five years ago when it started a process to end its heavy re­liance on print­ing pa­per by in­creas­ing the im­por­tance of chem­i­cal cel­lu­lose, or dis­solv­ing wood pulp (DWP), in its prod­uct lineup.

To do so, it ramped up DWP pro­duc­tion at its Ngod­wana mill in SA and Clo­quet mill in the US at a cost of US$460m.

DWP is used to pro­duce tex­tiles, qual­ity fab­rics and rayon. Other ap­pli­ca­tions in­clude cig­a­rette fil­ters, phar­ma­ceu­ti­cals, cos­met­ics and cel­lo­phane.

Sappi had lit­tle choice in the mat­ter. De­mand for newsprint and glossy, coated pa­per for mag­a­zines and cat­a­logues had been in de­cline for years.

The strat­egy to in­crease the im­por­tance of DWP has met with great suc­cess. In Sappi’s year to Septem­ber 2016, DWP con­trib­uted $294m (60%) of group op­er­at­ing profit of $487m, while at the earn­ings be­fore in­ter­est, tax, de­pre­ci­a­tion and amor­ti­sa­tion (Ebitda) level, its con­tri­bu­tion was $339m (46%) of a $739m to­tal.

DWP’s con­tri­bu­tion of 1.11Mt in vol­ume sales in Sappi’s past fi­nan­cial year was only 15% of to­tal group vol­ume sales of 7.25 Mt. Its Ebitda profit mar­gin was an im­pres­sive 36.5%.

Ex­panded DWP pro­duc­tion has been a ma­jor con­trib­u­tor to Sappi’s ro­bust per­for­mance, lift­ing head­line EPS (HEPS) from US7c in fi­nan­cial 2012 to 57c in fi­nan­cial 2016, which it­self had an in­crease of 67.4%.

In the process, re­turn on cap­i­tal em­ployed rock­eted from 5% to 20%, and re­turn on eq­uity (ROE) from 6.2% to 26.7%.

Sappi’s re­turns put it in front of its ma­jor com­peti­tors. These in­clude the world’s largest pa­per pro­ducer by vol­ume, In­ter­na­tional Pa­per (US), with a 17.7% ROE, Stora Enso (Fin­land) with 7%, WestRock (US) with 2.4% and Ja­pan Pa­per Com­pany with 11%.

With a 20% market share, Sappi is now the DWP market leader. It is a po­si­tion Sappi CEO Steve Bin­nie says the com­pany is de­ter­mined to re­tain, adding that it will add 500,000 t of DWP ca­pac­ity over the next five years. Of this, 100,000 t is set to come from “de­bot­tle­neck­ing” projects at the Ngod­wana and Saic­cor mills in SA in 2017 and 2018.

Sappi is not look­ing only to DWP to drive profit growth, but also to “mod­er­ate in­vest­ments in areas that of­fer growth and im­proved mar­gin”, says Bin­nie.

Here Sappi has a num­ber of tricks up its sleeve, in­clud­ing grow­ing sales vol­umes of higher-mar­gin spe­cial­ity pa­per used for high-end pack­ag­ing.

“Spe­cial­ity pa­per now con­trib­utes 15% of our Ebitda, com­pared with vir­tu­ally noth­ing five years ago,” says Bin­nie. “We want [it] to con­tribute a quar­ter of Ebitda by 2020.”

To that end, Sappi is con­vert­ing a mill each in the US and the Nether­lands to pro­duce spe­cial­ity pa­per.

Sappi is also shift­ing into “ad­ja­cent mar­kets”. The group is think­ing big, tar­get­ing new busi­nesses to add $100m (about 14%) in Ebitda by 2020.

One of a num­ber of inno- va­tive projects in­volves bet­ter use of tim­ber re­sources. Pa­per mak­ers, says Bin­nie, use about 50% of the tree to make pa­per. Sappi is in­vest­ing in tech­nol­ogy and pro­cesses to ex­tract high­value chem­i­cals and ma­te­ri­als from the re­main­ing 50%.

Bin­nie does not ex­pect such projects to re­quire Sappi to in­crease its net debt to above its self-im­posed limit of two times Ebitda. It cur­rently stands at $1.32bn, or 1.7 times Ebitda.

Sappi is set to de­liver an­other pos­i­tive set of results in its year to Septem­ber. How­ever, HEPS growth will fall far short of that of the pre­vi­ous year.

Among fac­tors work­ing against Sappi is a stronger rand, which has put the brakes on SA op­er­a­tions’ profit growth in dol­lar terms. Sappi gen­er­ates about half of its Ebitda in SA.

An­other neg­a­tive is a weaker DWP price, which peaked in Oc­to­ber 2016 at $975/t but fell 14% to $835/t in June.

But Bin­nie does not be­lieve this re­flects a market mov­ing into over­sup­ply. “World­wide ca­pac­ity will grow at 5%/year, in line with de­mand growth of 400,000 t/year,” he says.

The prospect of muted HEPS growth has re­sulted in Sappi’s share price re­treat­ing 15% from its May high. But the group’s solid medium- to longer-term prospects make it an at­trac­tive buy­ing op­por­tu­nity.

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