Unprecedented restructuring via mergers and mill closures is lowering costs as the industry tries to regroup after lackluster year

With Major Recovery Elusive, Mills Focus on Improving Performance

To reduce the volatility in pulp and paper markets, companies have focused on consolidation. In two blockbuster mergers this year, International Paper Co. (IP) acquired rival Union Camp Corp. for $7.9 billion and Weyerhaeuser Co. announced a takeover of MacMillan Bloedel Ltd., Canada’s largest paper and forest products group. This follows last year’s $2.5 billion merger of Avenor Inc. and Bowater Inc., creating the second largest newsprint manufacturer in North America.

Until recently, the paper and forest products industry appeared to be as focused on construction of new mills as it was on earnings and shareholder value. But the significant cost advantages of building new papermaking capacity in Asia and South America has changed the business environment forever. There is also motivation toward further consolidation because the U.S. is no longer a low-cost producer of paper products. With mergers, the potential for cutting costs is substantial. For example, since the former Abitibi-Price Inc. and Stone Consolidated Corp. merged in 1998, the successor company has reduced costs by over $200 million. Merging with Union Camp is expected to create $425 million in savings for IP.

“For the first time in the recent history of the industry, aggregate capital spending will be below depreciation levels,” commented John Linehan, an investment analyst at T. Rowe Price Associates.

Companies are purchasing paper mill assets rather than building new greenfield operations, a trend which has been pushed by Wall Street observers for years. “I think it’s vital for this industry,” said William Wigder, managing director of equity research at Credit Suisse First Boston Corp.

Moving into the second half of 1999, few pulp and paper companies will see big gains in revenue or net income. Commodity pulp and paper prices remain depressed worldwide and North American manufacturers have seen their share of international markets declining. This means careful management of mill capacity and an eye on operating costs.

George Mead, chairman of Consolidated Papers Inc. in Wisconsin, summarized the outlook for the remainder of the year. “We expect that the focus on our core business of coated paper, our cost-cutting measures, our continuing investment in technology, reduced capital spending, new product development, strengthened sales organization, and our loyal, hard working employees will help bring us through this temporary downturn.”

Pulp industry sees a brighter future. The market pulp industry is showing signs of sustainable recovery for the first time since the market collapsed in early 1996. Prices began turning upward in April 1999, reaching $520/mton in Europe for benchmark northern bleached softwood kraft (NBSK), and are likely to maintain their levels throughout the summer. This momentum could enable producers to seek modest increases in the fall, setting the stage for NBSK to reach as high as $650/mton by the end of 2000.

Despite the rosier picture, the pulp industry, as a whole, is not yet profitable. Some NBSK producers need $500/mton just to break even. The first-quarter price in Europe was only $460/mton and the June 1999 price of NBSK is still 9.6% below that of June 1998 and 7.1% below that of June 1997. In fact, the price is virtually the same as it was in June 1996, just a few months after it collapsed to $480 to $500/mton. In the three years since, prices have reached as high as $610/mton. But that, too, is a far cry from the price of nearly $1,000/mton during the almost two-year run-up that ended in fourth-quarter 1995.

Nevertheless, demand is improving worldwide, particularly in the key regions of Europe and Asia (except for Japan). A 1999 report by North American and Nordic (Norscan) and Brazilian industry associations forecasts demand to grow by an average of 2.5% per year in the period 1999 to 2001—a marked improvement from 1998, which saw a 1.4% decline. Because of seasonal slowdowns in Western Europe, which accounts for 45% of world demand, summer is traditionally a tenuous time for pulp pricing. In contrast to other recent years, however, European papermakers are not extending their typical summer shuts in 1999, so pulp buying is continuing at expected levels.

The other immediate good news for producers is from Asia, where demand has been picking up for some months now as the region recovers from the financial crisis that began in mid-1997 and sent the pulp industry into a tailspin. Non-Japan Asia/Africa accounts for nearly 20% of world demand and suppliers depend on the region to take incremental tonnage.

Producers are also encouraged by the prospect of smaller-than-usual increases in global market pulp capacity, coupled with the improved demand. The report forecasts that the demand-to-capacity ratio, down to 88% in 1998 from 91% in 1997, will rise to 91% in 1999 and 2000 and to 93% in 2001.

Capacity increases are expected to be limited for several years, marking a significant change for an industry that has been suffering from a constant state of oversupply. The Norscan/Brazilian report said world chemical market pulp supply was 38.3 million metric tons in 1998, only 1.5% higher than in 1997. It expects world supply in 1999 to decrease by 0.2%, the first time in 15 years that supply is expected to shrink. In addition, it forecasts capacity to increase by only 0.8% per year in the period 1999 to 2001.

Several reasons account for the change. Hard times and environmental challenges have stalled capital spending around the world. At the same time, various producers have shut unprofitable mills for the short term and in some cases, permanently; older mills that need costly environmental upgrades are less likely to restart. Other mills have been shuttered following the mergers and acquisitions brought about at least partly by some companies’ financial strains. In addition, companies in Asia and elsewhere that sold market pulp are now using the output instead for newly built paper machines.

New capacity has typically been showing up in the form of new lines to existing mills or through modifications to existing lines. In some years the latter approach alone can result in enough overall capacity creep to approximate the size of a new mill. With the trend toward acquiring capacity instead of toward building new mills, pulp producers will continue to incrementally boost capacity at existing operations.

Though the pulp industry is encouraged by the improved fundamentals, Research Information Systems Inc. (RISI) cautioned in June at the 5th International Market Pulp Conference that 1999 prospects could be dampened by other factors: inventory-building among papermakers and paper end users, only modest recovery in Asian economies (with Japan remaining "dismal"), and the negative impact of the startup of large woodfree paper machines in China. In addition, RISI observed that the pricing equation could be limited by the low, flat cost curve caused by weak fiber pricing, the closure of high-cost capacity, and low currency levels against the dollar.

Market slumps; prices hit 5-year low. Coming off two years of steadily increasing prices, the newsprint market hit a slump in December 1998 that has continued through the first half of the year, bringing prices down by $125/mton through June. In June, prices hit the lowest levels since 1994, falling to $480/mton in the East and $490/mton in the West. The market began to soften last year, just a few months after North American producers began to implement a $40/mton price hike on the backs of two major strikes which removed almost 1 million mtons of newsprint from the market. The strikes helped offset a serious import/export imbalance which came in the wake of the Asian financial crisis.

In late 1998, with both strikes resolved, newsprint prices began to tumble in December. Industry insiders say if not for the labor outages, the slump would have occurred in 1997-98, when North American exports plummeted from record levels and imported paper gained a greater presence in the U.S. market. In 1998, exports from the U.S. and Canada were down 22% from the previous year, according to the Canadian Pulp and Paper Assn. (CPPA). At the same time, Asian producers faced with weak demand and devalued currencies at home, began shipping increased volumes to the U.S. The U.S. imported 516,600 mtons of newsprint from offshore producers in 1998, a 150% increase over 1997, according to CPPA.

Downtime. Producers dealt with the oversupplied market by taking downtime and by permanently retiring newsprint capacity. Through June, North American producers had announced or taken an estimated 610,000 mtons of downtime, both market and maintenance-related shuts as well as permanent closures. The downtime (in metric tons), by company, follows: Abitibi-Consolidated In., 372,065; Bowater Inc., 127,000; Donohue Inc., 48,780; Fletcher Challenge Canada Ltd., 30,000; Kruger Inc., 4,000; Pacifica Papers Inc., 10,000; and Smurfit Newsprint Co., 18,000. The downtime represents about 3.6% of North American newsprint capacity.

As part of a plan to remove 350,000 metric tons of newsprint capacity by early 2000, Abitibi-Consolidated has permanently shut three newsprint machines: No. 2 at Chandler, Que.; No. 7 at Iroquois Falls, Ont.; and No. 2 at the West Tacoma mill in Steilacoom, Wash. The company also is converting 145,000 mtons of newsprint capacity to value-added grades at the Fort William mill in Thunder Bay, Ont.

The newsprint market is also expected to benefit from plans by some producers to reduce or eliminate newsprint production. Donohue will reduce production of newsprint and uncoated groundwood by 287,000 mtpy at its Lufkin, Texas, mill following installation of a new machine to produce supercalendered papers in mid-2000. About 170,000 mtpy of newsprint production may also be eliminated by the proposed new owners of Bowater’s Great Northern Paper Co. in Maine. Inexcon Inc. of Trois-Rivieres, Que., expected to acquire the company by the end of July.

Positive signs. The newsprint market has seen some positive signs of late, including lower operating rates, declining mill inventories, and the continued removal of capacity from the market. In May, Canadian operating rates dropped to 88% from 95% in April, the lowest since November. Total North American mill inventories also dropped for the first time since November. Canadian mill stocks were down 3.5% from April while U.S. mill stocks were basically flat, according CPPA. Still, North American mill inventory levels in May were about 25% higher than May 1998.

By mid-year, some sources said they believed prices were close to stabilizing, and expected the market to benefit from several factors in the third and fourth quarters: increased ordering to rebuild lower-than-normal publisher inventories, seasonal demand in the fourth quarter, and year 2000 (Y2K) related demand, both from a projected increase in consumption and inventory building to hedge against supply disruptions.

However, some newsprint buyers say they won’t substantially increase inventories in anticipation of Y2K and say they are confident in suppliers’ Y2K compliance. "Building inventory is not the way to go. We just need to manage it better by getting it out of transit early and into the warehouse," commented one buyer.

CAPACITY GROWTH REMAINS STRONG. Expansion activity in the North American tissue market continues to be very active with a number of projects completed earlier this year and several new tissue machines announced to be installed.

An additional 11 new machines are scheduled for start-up in the period 1999 to 2001 in the U. S. Including capacity gains from a number of tissue machine rebuilds and the expected restart of a fourth machine at Global Tissue LLC (formerly Shepherd Tissue Inc.) in Memphis, Tenn., a net increase of over 550,000 tons of additional capacity is scheduled to begin production through 2001.

Shepherd Tissue was acquired by Montreal-based Kruger Inc. in February and renamed Global Tissue.

CityForest Corp. was scheduled to begin production on its new No. 4 tissue machine in July at its mill in Ladysmith, Wis. The company started up a new 100 tpd deinked pulp (DIP) line in May to supply the new machine. The new pulp line will also allow the mill to utilize lower grades of recovered paper than possible with its current recycled fiber equipment. CityForest shut down No. 3 machine at the Ladysmith mill in April and the No. 2 machine in June.

Marcal Paper Mills Inc. began trial production on its new 65,000 tpy machine in late December, slightly ahead of schedule.

Plans by Wisconsin Tissue Mills Inc., a wholly-owned subsidiary of Chesapeake Corp., to build a greenfield tissue mill in Weldon, N. C. were put on hold in late June. Georgia-Pacific Corp. (G-P) and Chesapeake announced that they will form a joint venture combining their away-from-home tissue businesses, with G-P owning 90% of the joint venture. A final decision to build the greenfield mill is expected to be made in the fourth quarter after formation of the joint venture is completed, which is expected in October following completion of due diligence and regulatory approval. The installation of a new tissue machine at G-P’s mill in Zachary, La., which was first announced in May, is still on schedule to start production in late 2000.

PCDI Oconto Falls Tissue LLC is currently installing a second Voith Sulzer Crescent former at its mill in Oconto Falls, Wis. The company’s first machine began production at the former Kimberly-Clark Corp. deinked pulp (DIP) mill in July 1998. The $26 million project is expected to begin production in October.

Perkins Paper Ltd. is proceeding with its plans to install a 30,000 tpy tissue machine at its mill in Rockingham, N. C. The $25 million expansion is expected to be completed in the first half of 2000. Procter & Gamble Co. is on schedule to begin production on two new machines at its greenfield mill in Cape Girardeau, Mo. in 2000.

Edwards Paper Co. Inc. is currently building its second recycled fiber-based tissue mill in Tucson, Ariz., with start-up of the 15,000 tpy mill scheduled for February 2000. The company is also exploring options to build a third tissue mill in the upper Midwest. Areas that have been mentioned are Detroit, Mich., Pittsburgh, Penn., Cleveland and Toledo, Ohio, and northern Indiana.

The only other proposed tissue machine project in development is by Firstar Fiber Inc., Omaha, Nebr. Firstar has received an additional $1.5 million from the Nebraska Environmental Trust for project development in 1999-2000. Engineering work is scheduled to begin this summer while efforts to raise the estimated $50 million required for the 35,000 tpy tissue mill are accelerated. The company is also considering installing some converting capacity at the mill for converting up to one-third of the mill’s production.

IP, Union Camp join forces; markets mostly lackluster. The merger of two of North America’s largest papermakers dominated developments in the printing/writing paper markets during first-half 1999. IP and Union Camp Corp. completed their $7.9 billion merger in April. The combination radically changed the makeup of the North American uncoated free-sheet and containerboard markets, boosting IP’s share of the former to more than 20% of capacity. The combination was expected to result in $425 million of cost savings by the end of 2000.

Another merger also shook up the sector, that of G-P and distributorship Unisource Worldwide Inc., the U.S.’s largest merchant. Unisource originally agreed to be bought by UGI, a utility in eastern Pennsylvania, until G-P stepped in with a $851 million bid. G-P said it could deliver $75 million annually in savings over the next two years. Unisource has been a somewhat troubled company, and posted a $231.8 million loss on sales of $7.42 billion last fiscal year.

In other merger and acquisition news, Simpson Paper Co. continued divesting itself of paper assets, selling a coated and uncoated paper mill in Anderson, Calif. to Plainwell Inc., which already owned another former Simpson mill in Michigan. Simpson also completed the sale of its Pasadena, Texas, paper mill to Belgravia Paper Co. Champion International Corp. sold its Deferiet, N.Y., groundwood papers mill to Crabar Paper & Allied Products Corp. American Tissue Holdings Inc. bought Crown Vantage’s pulp and paper mills in Berlin and Gorham, N.H.

IP, Willamette Industries Inc., and Sappi Ltd. all closed machines at large mills, due to cost considerations, taking capacity out of the coated one-side label and release paper market. Consolidated Papers Inc. retired a machine at its Niagara, Wis., coated groundwood mill, taking out 30,000 tons and indefinitely shut down a machine at its Biron Div.; Fraser Papers Inc. took out two paper machines at mills in the Midwest.

U.S. printing/writing paper capacity is expected to grow at only a 0.8% average annual rate through 2001 to 29.67 million tons. Canadian printing/writing capacity is set to grow at an average annual rate of 4.5% through 2001 to 6.6 million mtons. The major part of the growth will take place in the uncoated groundwood printing papers market, due to conversions from newsprint and machine speedups.

Markets flat. The good news in the printing/writing paper markets in the first half of the year was--except in the case of uncoated groundwood—that there were no wide price swings. However, prices were still soft, running generally 10% to 15% below 1997 and discounted heavily off list. Imports from Asia and Brazil as a result of financial crises there, had a major dampening effect on North American prices in 1998, and that continued through most of 1998, although there was some slowing. Increased imports aggravated an already oversupplied situation and although some downtime was taken, it was not enough to tighten markets that had plenty of inventory.

U.S. consumption of printing/writing paper was up in 1998 by about 2% to 30.87 million tons, due mainly to increased imports and decreased exports. Shipments were 26.5 million tons, down a slight 0.4%.

Producers were able to increase prices on several uncoated free-sheet grades including converting during the spring by about $40/ton. Another price initiative was proposed for July. Coated printing paper prices remained heavily discounted off list during the first half, bottoming out in March. Citing better order books and higher pulp prices, producers began narrowing discounts in June and a coated web increase was proposed for mid-July. Although suppliers tried to discourage it, there was talk about stock building in the fourth quarter to mitigate any perceived ill effects from Y2K. So far, there was little evidence it is occurring.

The uncoated groundwood market started 1999 in good shape with prices rising due to the residual tightness from the Abitibi-Consolidated Inc. strike. But that was short-lived as machines went back online after the strike was settled. Newsprint and groundwood specialties were off about 10% from the beginning of the year as June rolled around. Additional capacity in North America and overseas as well as consolidation among directory paper buyers could mean this market may be problematic for some time to come.

Market reverses, on an upswing. In a turnaround so quick that even industry veterans were surprised, U.S containerboard prices moved from their trough at the end of December 1998 to a new peak by July. The rapid turnaround was caused by two reasons: North American producers eliminated 6% of containerboard capacity at the end of 1998, and demand for corrugated containers remained steady, growing at or nearly 2% above 1998 volume.

For the first time in 16 months, North American producers implemented a combination linerboard and corrugating medium increase for $50/ton and $60/ton, respectively, in February/March. A medium only increase of $20 to $30/ton was implemented in May through July. And producers planned another increase for July 1 of $40/ton on linerboard and $50 to $80/ton on medium. The new prices would be the highest in 3H years.

The prices increased this year, after seven months of decline in 1998, because several U.S. producers shut down what amounts to 2.2 million tons of annual capacity, and because producers eliminated an estimated 1.9 million tons of capacity with market-related downtime in the final seven months of 1998.

The benchmark 42-lb unbleached kraft linerboard grade ended 1998 at $335 to $345/ton in the East. By June, it had moved up to $385 to $390/ton. The increase in medium was more significant. The price for 26-lb semichemical corrugating medium in the East was $265 to $275/ton at the end of 1998 and by June was $345 to $355/ton.

Through May, U.S. box shipments were up 1.6% on an average-week basis over 1998 shipments through May. First quarter U.S. Gross Domestic Product (GDP) growth was 4.1%, helping to push along demand for consumer products and boxes.

Major North American containerboard producers expected the July increase, if fully implemented, would bring prices for linerboard in the East to about $425/ton and bring prices for medium to about $405/ton (East Coast). They would be the highest linerboard and medium prices, respectively, in the U.S. since January 1996.

Exports mixed. The other main piece to the demand puzzle—the export market—was a mixed bag through first-half 1999. Still, it had improved from extreme weakness from September through October 1998. Demand for North American kraft linerboard improved in Hong Kong/China, a key export market for U.S. linerboard. This helped North American producers implement a $55/mton increase for lightweight linerboard to Hong Kong in March through May. Another key reason for the higher prices was a move out of the export market in Asia in early 1999 by two major U.S. producers, Smurfit-Stone and G-P. In Latin America, North American linerboard exports remained steady through first-half 1999, especially to Ecuador and despite the damage from Hurricane Mitch to several countries in Central America.

However, U.S. exports to Northern Europe (U.K. and Germany) were weak, as was pricing through June 1999. North American producers tried to implement a $55/mton increase on heavyweight linerboard but were unable to get the increase in across the board. About $10/mton was in place by the end of June. North American producers continued to pursue price increases in the U.K and Germany in the third quarter of 1999. Prices did move up in the first half of the year the full $55/mton in Italy and Spain. But the higher prices only brought the price levels in Spain and Italy up to comparable level with the pricing in the U.K. and Germany for North American linerboard.

In the U.S. and Canada, box makers followed the containerboard price increases in February/March with an increase on boxes of 10% to 14% in primarily March and April. Box makers also proposed increases of 10% to 12% for July and August.

GDP key. A key issue in the second half of the year will be the economic demand for boxes. U.S. GDP is estimated to grow 3% in the third quarter and 2% in the fourth quarter, according to J.P. Morgan Economic Research. Canada’s GDP is forecasted to grow 2.8% and 2.2% in the third and fourth quarters.

If box shipments increase more than 2% over 1998 levels, some integrated producers have informally suggested that another price increase might be warranted in 1999. Key to that possibility will be the buying strategies of box users in November and December heading into the millennium.

In recap, the turnaround in market prices has been a direct result of the reduction in the supply line. The principal mover in that regard was Smurfit-Stone. After Jefferson Smurfit Corp. acquired Stone Container Corp. in November 1998, the newly-created company announced the indefinite shutdown of 1.075 million tons of capacity at four mills. One of the mills already was being dismantled in June. A fifth mill that Stone Container had an interest in, the 480,000 tpy Florida Coast Paper LLC mill, was also indefinitely shut, and filed for bankruptcy protection. IP also indefinitely shut down the 340,000 tpy Gardiner, Ore., mill and the 252,000 tpy No. 6 machine at the Savannah, Ga., mill. Packaging Corp. of America indefinitely shut a 70,000 tpy machine at the Filer City, Mich., mill.

Along with the slimmer supply line, there are only two projects planned for adding containerboard capacity in North America in the next 1H years. Solvay Paperboard LP planned to start up a 200,000 tpy heavyweight linerboard machine in August, and ReBox Paper was working on plan to build a 140,000 containerboard mill in Wisconsin in late 2000. Weyerhaeuser Co. dropped its plans in June for building a 650,000 tpy containerboard mill in Fulton, Ark.

SPENDING UPTURN EXPECTED. Capital investments by North American paper and forest product companies are expected to increase slightly in 1999 following three years of declines. Current fiscal 1999 spending estimates by 54 U. S. and Canadian-based companies total $9.52 billion, an increase of 6.7% over actual spending in 1998.

A four-quarter rolling total of reported capital expenditures through first quarter 1999 by 40 U. S. and Canadian paper and forest products companies showed a decline of only 0.5% from fourth quarter 1998 to fall to $7.65 billion (Figure 1). However, this decline, the ninth consecutive drop recorded since fourth quarter 1996, is the smallest quarter-to-quarter decline over the past two years.

Figure 1: Capital spending should increase slightly in 1999 following several years of sharp decline.

In Figure 1, each data point is a four quarter rolling total and is based on a calendar year, not fiscal year. For example, the data point for first quarter 1999 is the summation of actual spending reported from April 1998 through March 1999 for the 40 tallied companies.

The first quarter 1999 rolling total for U.S. companies declined 1.5% from fourth quarter 1998. However, this decline was offset by a 5.0% spending increase by Canadian companies, resulting in the total decrease of only 0.5%. Spending by U.S. companies accounts for approximately 85% of total North American spending in this tally.

The rolling total declined 3.0% in fourth quarter 1998 compared to third quarter 1998 which came on the heels of a 4.4% decline in third quarter 1998.

Including revised estimates for 1999 capital spending plans, spending should increase over the April to December period. Based on current company estimates, the four quarter rolling total should reach approximately $8.1 billion in fourth quarter 1999, an increase of 5.1% compared to fourth quarter 1998.