Tuesday, March 18, 2008
As AbitibiBowater, North America's Largest Newsprint Producer, Fights To Avoid Becoming Another Bear Stearns, Norway's Norske Skog Announces More Cutbacks, US Newspaper Groups Brag At Huge Newsprint Usage Declines, And China Ramps up Newsprint Production and Exports
BY Philip M. Stone
The merger of Abitibi and Bowater last October was supposed to form North America's largest newsprint producer that could, with the cost savings a merger between two such giants should produce, finally get the upper hand on production and pricing. Instead its shares are down nearly 70% so far this year, off 15% alone on Monday because the markets don't think its recently announced $1.4 billion refinancing plan will fly.
Meanwhile North American newspaper groups are boasting to their shareholders about the cost savings they are making by using less newsprint.Gannett, the largest US newspaper publisher, reported newsprint expense declined 25.3% in Q4, 2007, due to usage prices that were 8% down, and almost 19 percent lower volume. At the New York Times Company newsprint expense for Q4 declined 30.3% with 16% coming from lower consumption and 14.3% from lower prices. Newsprint costs are thought to consume around 20% of a newspaper's costs.
Those savings did not come by accident. Newspapers have been very busy in the past few years cutting the width of newsprint from 15 inches down to 12 (38cm down to 31cms), converting to lighter weight paper, confining to the web financial tables that used to consume three or four pages daily, reducing the news hole, cutting back on distribution areas, dropping most bulks sales, not to mention the classified advertising debacle that has seen many metropolitan newspapers that used to run two or more sections daily of classifieds now down to just running a few pages. Add all of that up and no wonder newsprint consumption is down by double-digit percentage numbers.
AbitibiBowater has been busy since its October merger shutting down mills and reducing the workforce -- in February it sold a newsprint mill in Arizona and it's selling timberlands in the US and Canada as it attempts to pay off debt. In its first quarter as a merged company it reported a $250 million loss, with analysts basically saying all of its attempts to cut costs still have not caught up to the 12% decline in December newsprint usage over the year before.
And on the other side of the Atlantic, Norske Skog, Europe's largest newsprint producer and second globally to AbitibiBowater, says it has been hit by rising energy costs and lower newsprint demand. It announced last week it was cutting capacity by 7% -- shut 450,000 tonnes of newsprint production at three mills in Norway, the Czech Republic and South Korea -- as the company works on reducing its $3 billion (€2 billion) debt mountain. Its shares have sunk some 80% in the past year and are now selling at 20% of book value. It has quit paying dividends.
And the outlook for newsprint consumption in Western Europe, like in North America is not looking good. Europe is the leader in the free newspaper industry and one might have thought all of those free newspapers would have pushed up European consumption, but those free newspapers are only responsible for about a 5% uplift, according to the Pulp and Paper Products Council. One reason for that is that while there may be a lot of free newspapers, they are printed in mostly small A5 size (230cm x 320 cm - 9 inches x 12.5 inches). And making matters somewhat worse there is a "survival of the fittest" war going on with the weak free newspapers dropping by the wayside.
"Newsprint demand in Western Europe has held up due to growing consumption by free newspapers,"according to Emanuele Bona, European Vice President for the Pulp and Paper Products Council, but he sees storm warnings ahead. "The other key drivers of demand have been falling -- circulations of paid-for titles, pagination, and advertising spending on newspapers have all been weakening."
In his view Europe won't see any consumption increase this year, but he doesn't expect to see the decline that North America has been experiencing although there are storm warnings out there. "Now that the contribution of free newspapers to newsprint demand seems to be waning, as most markets become saturated, we don't expect to see any overall growth in consumption in Western Europe," Bona explained. But he warned, "The weakening economic environment will have a further negative influence on the circulation, pagination and ad pages.
"However, we don't expect Western Europe to show the sharp decline in newsprint demand that we have seen in North America (demand fell over 10% last year, and 33% or 4.3 million tonnes since 2000), but we can certainly anticipate the beginning of a structural decline on this side of the Atlantic as well," he said.
AbitibiBowater is trying to dig itself out its hole not just by reducing production but also by raising newsprint prices - a $60 a ton increase for Q1 seems to be holding bringing prices to around $620 a tonne and the company has announced a similar increase to be phased in during Q2. On the other hand, US newspaper newsprint consumption is expected to decline within a 9%-12% range this year.
The declining dollar is giving AbitibiBowater export opportunities - looking mostly to South American markets but also to India and Europe where prices are higher -- just what Norske Skog needs! "We intend to increase our newsprint export shipments in 2008 by nearly 10%," according to AbitibiBowater Chief Executive David Paterson.
Not to be discounted in all of this is China's announcement that its newsprint production - using new energy-efficient mills plus recycled raw materials - has risen 5.7% so far this year to 689,000 tons. There had been thoughts that China would find it worthwhile exporting to the US West Coast giving North American producers price competition they would not welcome, but the declining dollar probably has probably put an end to that and so the Chinese are looking more and more at India. The bulk of India's newsprint imports now come from North America.
It seems that few weeks go by without the announcement of another Indian newspaper launch. Domestic Indian newsprint consumption is currently thought to be around 2 million tonnes, but that is expected to grow in a year by about 20% as plans are announced for new publications as well as increasing pagination and the number of editions of current newspapers. Currently about half of the demand is met domestically - but not preferred for color printing on quality issues -- and in a country known for high import taxes, newsprint gets away with just a 5% duty.
Increased demand has led to higher prices and a spokesperson for one Indian publication said that whereas in Q4, 2007 the price was around $675 a tonne it is now running around $750 - $760 a tonne. Those types of prices make it profitable, for North Americans to export. According to Resource Information Systems, US East coast prices, ready for shipment, have risen from $608 a tonne to $710, and is expected to rise to $770 by Q3. The thought in India is that before this year is out prices will reach around $850. No wonder that is the world's newsprint export market of choice!
In India the higher prices are a bigger problem than elsewhere because wages are relatively low, so newsprint is responsible for up to half of a newspaper's costs, even more perhaps for smaller newspapers. The big guys will survive, but will the smaller newspapers?
Globally, according to RSI, demand at the beginning of 2007 was around 38.3 million tonnes, and the supply was some 2.2 million tonnes in surplus. That's why the paper companies have been busy shutting down mills and by now most of that spare capacity is gone - thus the climate for price increases.
The question now is whether AbitibiBowater, having done what is necessary to stay in business, now will have the finances to stick around and reap the rewards.
Wednesday, March 12, 2008
Weathering a Stormy Paper Market Forecast
By Alex Brown
What's behind the market's drastic changes, what to expect next, and how you can deal with higher prices and tight supply.
There's no sugarcoating it:
The paper market is bleak for buyers. The problems lie in both price and availability, and the forecast for 2008 has almost no bright spots. So, several questions have emerged: How did we get here? What can you do to cope with this new reality? What trends may affect paper purchasing this year and beyond?
First, it's easy to be puzzled by how the paper market changed so abruptly and intensely. Paper buyers have seen the dark clouds massing over the mills for years, but little has come of it. Why is it actually raining now?
In the last five years, we've seen several mill closures. Tembec and UPM closed mills, and other mills shut down individual machines. The net effect was a drop of at least 20 percent of North American coated-paper capacity. As the first of these closures occurred, paper availability might have tightened a bit, but there always seemed to be another ready source of supply.
Now the industry has finally carried its capacity reduction to a point that supply is constrained both here and in Europe. It moved in what looked like baby steps, but, in the end, a real distance was crossed. Depending on the specific stock, demand is now very close to or in excess of supply.
Let us consider the paper industry's perspective for a moment. If you've watched the market through several cycles, you've probably noticed that the mills seem to have forgotten a little section of "Economics 101"-namely, commodities prices can rise when demand exceeds supply. So why, you might have wondered, didn't mills limit capacity sooner?
We'll leave out some of the variables, but there are two key reasons why shutting down machines hasn't been a shortcut to profitability. First, the enormous capital costs of papermaking mean mills become profitable only when capacity utilization is extremely high. Roughly speaking, a mill might start turning a profit when it's producing about 95 percent or more of all the paper it could possibly make. Notice the limited upside, as well as the long, brutal road to profitability. The gap between losing money and making money is very, very narrow.
The second reason mills tend not to adjust capacity tightly to demand is that there are two levels of competition for the U.S.-paper dollar. Domestic mills battle each other, and then they balance foreign paper sources with all the extra complications of currency exchange.
For the last several decades, whenever demand edged sharply above U.S. capacity, European and Canadian mills were a handy safety valve. Asian and South American sources have also entered the mix. For much of this time, the dollar's currency strength has made exporters keen to court the large market in this country.
However, we've all but lost this safety valve against supply/demand tension now that the exchange rate with both the euro and the Canadian dollar is so poor. A Finnish mill would very much prefer to sell paper to Germans, in euros, than to Americans.
Then again, what exactly is a "Finnish mill" these days? The paper industry is consolidating into international entities. But that doesn't provide any relief under our current conditions. In fact, the consolidation is not merely a compression of sources, but a new style of ownership.
Five paper companies-NewPage (which has acquired Stora Enso North America), Verso, Catalyst, Pine Bluff and West Linn-are now owned by private-equity concerns. Add up the volume these mills represent, and you'll find that private equity controls 62 percent of the coated groundwood market in North America, and 57 percent of the coated freesheet.
These companies play by new management rules. They want return on investment, they want it promptly, and, presumably, they want to sell the underlying assets as soon as they're sufficiently buffed up to make the sale worthwhile.
To some degree, even paper buyers could benefit from the new management style. Perhaps an industry that's struggled for so long to scratch toward decent margins can and should be shaken up. But it's fair to say that the new trends in management, which may spill over to other, publicly traded mills, are not designed to ease the buyer's sufferings. If a price increase can be supported, a price increase will be made.
So that's how we got here: reduced supply, the falling dollar and private-equity ownership. These conditions justified price increases, and mills have shown the fortitude to demand them.
Are the mills happy yet? Not really. Despite the 2007 round of price hikes, increases in the direct costs of papermaking have munched up much of the revenue. Fuel oil, which affects both papermaking and shipping, is the main villain, but raw materials' prices have also been increasing. In short, if the market can support further price increases, they're on the way. Look for bumps in April and, perhaps, July.
What's the Buyer To Do?
The paper buyer is left without many tactics. In broad terms, the only force that can mitigate the current paper price increases is a drop in demand still greater than the so-so to negative growth we've been seeing in the magazine and catalog markets. So, this is good news/bad news time: If your pages and counts drop still more, maybe the mills will ease off, but then your pages and counts will have dropped. If you're growing or holding your own, it may be difficult to get paper, but you'll be growing. If a lot of us are growing, prices are going to keep rising.
Let's break out the emergency flotation devices, then. To fight the impact of price increases, you can reduce basis weight, trim size, paper grade or, of course, pages and copies.
Cutting basis weight will work just fine, provided your new weight is available. Because we're struggling with both price increases and supply shortages, check the practicality of your new spec before announcing to the publisher that changing from 38 pound to 35 pound saves 8 percent. Be sure that the mill makes the weight you want, as plenty of them have basis-weight preferences.
A trim-size cut means the art staff and ad-traffic team must update templates and revise the specs in media kits. There's some work and cost to be considered right there, and it's only worth spending if you have your printer's cooperation. Switching to short cutoff presses, for example, only works if there is capacity. Publications that use a wide, 9-inch luxury format can make the change by ordering a new roll width, but if that distinctive trim size is key to audience and advertiser appeal, consider this carefully.
Changing paper grade can save a great deal, as long as it doesn't require throwing the baby out with the bath water by harming your publication's stature. If you're already on a #5 grade, the next train leaving the station is supercalendared stock. This paper performs quite differently, and you'll need your printer's commitment to make it work. Brace yourself for an increase in ink costs, as the more porous surface absorbs more. Finally, any grade change may cause you supply problems when adjusting your allocation.
Despite the caveats, all three of these adjustments can be smart techniques for controlling costs today. Make sure they suit your product and your audience, and get your printer and paper supplier to help carry them to fruition.
The other key concern is guarding your ongoing paper supply. It's safe to say that mills have taken on a go-ahead-make-my-day demeanor-if you fight too hard for better prices and terms, the mill doesn't mind an excuse to cut your allocation. Tread cautiously.
As business practices become increasingly hard-nosed, it's almost quaint to imagine that business relationships still matter. Private-equity owners are ready to be just as cutthroat as you are, so good, old relationships don't count for as much as they used to. But with the magnitude of supply cuts now and in the immediate future, a good connection with a mill or broker is one of the few shelters in this storm. You might even want to pick up the tab for lunch.
The dollar is almost certainly going to continue its swoon, so don't look for much help from Europe. Asia, however, appears to be another matter. The currency problem is just as nasty against the yuan, but China and Indonesia have shown a strong interest in cracking our mighty market.
Will shipping Chinese paper across an ocean and half a continent fix things? Not so fast. The price of pulp is higher in Asia, where fiber sources include imported pulp. Asian mills began introducing their wares at startlingly low prices, but have steadily edged upward and no longer look like a bargain. The currency exchange problem and the threat of a future tariff all suggest that Asian papers will not radically alter our paper landscape.
Our ace in the hole, it's sad to say, is a continued drop in demand that forces mills to choose between cutting still more capacity and selling at prices more favorable to buyers. Needless to say, a drop in demand comes along with lots of other depressing baggage, including the sight of publishers falling by the wayside. But those who remain strong may be able to reap benefits. In other words, the publishing market may experience its own shakeout, courtesy of rising paper prices-and let's not forget the hike in distribution costs that completes the one-two punch.
The major question is not how much mills may raise prices, but how gradually. If private-equity thinking leads the way, we may see a steep curve upward, sharp enough to kick some buyers out of the market, or constrain growth. The resulting drop in demand could kick right back at the mills. If mills take it slowly, they might end up with both profits and customers.
Prepare for more increases this year, inventory your specifications to see if you can change what you buy, and pay attention to your supplier relationships to keep the paper flowing. These are challenging times, but smart paper buyers will survive them.
Alex Brown is a consultant to magazine publishers specializing in manufacturing and magazine management. She founded her consulting company, Printmark, in 1984, and is a frequent speaker at industry events.