Companies continue to maintain a disciplined spending approach in line with new investment strategies

Spending Low as North American Companies Show Fiscal Restraint

While up slightly from last year, the current U.S. figure is still amongst the lowest recorded during the past 20 years and is down over 45% from the most recent spending peak of $13.6 billion in 1996. The Canadian spending total is the lowest since a reported C$2.8 billion tallied in the 1980 survey.

A summary of reported expenditures at U.S. and Canadian pulp and paper operations for the survey period 1999 to 2001 is reported in Table 1, with data broken out by project type and geographical region. Projects with firm completion dates in 2002 have also been summed in these totals, though they represent a very small portion of the total spending. Historical data for the previous 20 years is shown in Figures 1 and 2.

FIGURE 1: While total spending remains low, Cluster Rule projects offset drops in investments in capacity expansion projects.

FIGURE 2: Low Canadian totals reflect low commodity grade investment levels.

ADOPTING A NEW FISCAL PHILOSOPHY. The North American pulp and paper industry has adopted a new long term philosophy regarding capital investments in the late 1990s heading into the 21st century. As a result, spending levels have fallen to historic lows in the past several years and seem unlikely to rise significantly in the near future.

Historically, capital spending by North American companies has typically been 1.5 to 2.5 times the level of depreciation and amortization, resulting in significant investment in the industry. A ratio of capital expenditures to depreciation greater than 1 means that investments in new equipment have exceeded the decrease in value of existing equipment. This excessive investment has been a significant contributing factor to the cyclical nature of the industry.

Typically, following a peak in paper and/or pulp prices, companies have plowed their profits into building new capacity. Commonly, however, this new capacity has resulted in a subsequent glut in available supply, causing a sharp downturn in prices and profitability.

Beginning in the 1990s, companies have gradually adopted a more rigorous view towards capital spending. Consequently, the ratio of spending to depreciation has gradually fallen during the decade. However, following the extreme rise and fall of pulp and paper prices in 1995 and 1996, increased pressure from the Wall Street investment community has convinced companies to be far more judicious in their capital expenditures. As a result, a large number of companies have publicly committed to limiting their capital expenditures at or below depreciation levels in the past few years, a radical change from spending patterns over the past decades.

International Paper Co. (IP), the world’s largest paper company, has maintained spending at or below depreciation levels since 1997. The company expects that total spending in 1999 and 2000 will be approximately 80% of depreciation (a ratio of 0.8), totaling approximately $1.2 billion each year. IP’s spending priorities are “to lower costs, improve quality, consolidate facilities, meet compliance for things like Cluster Rules, and enhance information systems.” Subsequently, “new capacity and incremental capacity projects are not high on our priority list.”

Weyerhaeuser Co. also expects its final 1999 spending to be less than depreciation costs and plans to maintain a tight rein on spending going forward. The company plans to “invest prudently while maintaining long-term stability,” according to a company spokesman. Weyerhaeuser has developed the Process to Achieve Excellence (PACE) process to closely review and monitor all proposed spending projects. If a project is determined to meet the company’s strategic objectives, the management of the process is closely tracked. The PACE process has proven to be very successful for Weyerhaeuser not only in selecting strategic projects but also in bringing projects to completion faster and under budget in many cases, without sacrificing worker safety.

Georgia-Pacific Corp. (G-P) has used the Economic Value Added (EVA) model for a number of years as a determining factor in its investment decisions. Any proposed project must show that it can earn above the cost of capital before being funded. Additionally, G-P has maintained strict adherence to limiting capital expenditures at or below depreciation levels since 1997 while investing in businesses which show strong growth and business potential, including tissue, gypsum wallboard and chemicals. Other companies that have adopted the EVA methodology are Mead Corp. and Boise Cascade Corp., amongst others.

Fort James Corp. has also maintained capital spending at or below depreciation levels since 1996 while Smurfit-Stone Container Corp. plans to keep capital spending in the range of 50% to 60% of depreciation (a ratio of 0.50 to 0.60).

In addition to this renewed emphasis on strategic investment, companies were once again very busy in 1999 continuing to restructure their operations. The number of mergers and acquisitions and machine and mill closures continued at a rapid rate during the past year. A list of major mergers and acquisitions can be found in the Outlook 2000 article.

The large number of machine and mill shutdowns during the past two years has also proven to be successful in improving market conditions. The permanent removal of over 1.5 million tons of containerboard capacity and over 300,000 tons of market pulp capacity by Smurfit-Stone Container Corp. has been a major reason for the improved conditions in those markets. Other major market pulp capacity reductions include Bowater Inc., Gold River, B.C., Kimberly-Clark, Mobile, Ala., Pasadena Paper Co., Pasadena, Texas, and International Paper Co., Selma, Ala. A complete list of all reported permanent pulp and paper mill operations in the U.S. and Canada can be found in the Outlook 2000 article.

With industry emphasis being focused more on strategic investments and corporate restructuring via mergers, acquisitions and closures, it is no surprise to see that capital spending plans have been kept to a minimum yet another year. Companies have found it more financially attractive to buy additional production capacity than to build it. And a number of companies have taken a close look at their operations and made the difficult decision to close high cost, outdated equipment and facilities.

P&P Survey Results: United States. Total U.S. spending is reported to be $7.4 billion for the 1999 to 2001 period, a 2.2% increase reported from last year’s survey total of $7.2 billion. This also marks the third consecutive year of U.S. project spending below $10 billion since the late 1980s. Spending peaked sharply at $18.0 billion in 1990 and declined steadily to $12.0 billion in 1994 before spiking again in 1995 and 1996, peaking at $13.6 billion in 1996.

Tallied spending for new paper machines fell more than $700 million from last year’s survey to total just over $900 million. In the past two years, identified project spending for new machines has plummeted by $1.4 billion from the total of $2.3 billion reported in 1998. In conjunction with the second consecutive year of record low capacity growth for paper and paperboard forecast by the American Forest and Paper Association (AF&PA) through 2002 (see “Newsscan” item, p.15), there are far fewer new paper machine installations slated to come online in the U.S., with none currently committed to begin production beyond 2000.

Table 2 identifies the 13 new paper machines scheduled to begin production during the survey period. Of the 13, four began production in 1999 with the remaining nine scheduled to begin production in 2000. The 13 new machine installations is about one-third less than the number reported in recent surveys, an indication in the dramatic cutback in spending for new machines.

The tissue segment continues to be responsible for a majority of the new machine installations, also continuing a trend observed in last year’s survey. Three new tissue machines started in 1999 and four additional machines are slated to begin production in 2000, including two new machines by Procter & Gamble Co. at its greenfield mill in Cape Girardeau, Mo.

Two new machine projects were canceled during the past year. The proposed greenfield tissue mill by Chesapeake Corp. was canceled after it combined its tissue operations with G-P in mid-1999. And Caraustar Industries Inc. opted to form a joint venture to convert an existing machine to produce gypsum facing paper.

Spending on machine rebuilds increased by $110 million from last year’s survey, rising to over $1.3 billion. Combined, spending for new machines and machine rebuilds fell from 40.3% of total reported spending in last year’s survey to 30.8% this year.

Spending for environmental projects more than doubled from last year to total over $2.3 billion in this year’s survey, up $1.5 billion from last year. This sharp increase is not unexpected as companies have begun to authorize the necessary projects for mills to meet the more stringent environmental requirements of the Cluster Rules legislation. While a number of companies have already invested to comply with the new regulations, many are in the midst of making necessary process modifications to meet the stricter emissions guidelines.

There is still a significant number of proposed projects to build greenfield mills or install new machines in the U.S. Several of them appear to be very slowly moving closer to obtaining financing to begin construction while others continue the arduous task of raising capital in a business climate that is discouraging investments for additional capacity. It is interesting to note that the majority of proposed projects in the U.S. are not being developed by established paper or forest products companies. Rather, they are spearheaded by independent developers.

P&P Survey Results: Canada. Spending at Canadian mills is tabulated to decrease 23.0% to tally only C$2.5 billion for the period 1999 to 2001. This is the lowest spending reported since the C$2.8 billion reported in the 1980 survey. The biggest reason for the large decrease is the removal of the C$750 million invested by Stora Enso Port Hawkesbury for its 1998 installation of a 350,000 mtpy SC-A+ papers machine which is no longer in the spending tally.

As the selling price for both market pulp and newsprint fell to cyclical lows during 1999, companies had reduced cash flow, limiting the amount of cash available for investment projects. And with the ongoing implementation of limiting capital expenditures to at or below depreciation levels by many Canadian companies, the number of confirmed projects has dwindled.

There is currently only one ongoing new paper machine installation in Canada, as shown in Table 4. The new 152,000 mtpy uncoated groundwood papers machine by Alliance Forest Products in Donnacona, Que., is scheduled to begin production in 2000. The new machine will add only 62,000 mtpy of net capacity as Alliance will end production on two old smaller existing machines at the mill.

Paper machine rebuilds accounts for just less than one-third of all identified spending projects in Canada for the survey period. Companies are investing in strategic rebuilds of existing equipment to provide improved paper quality and/or reduced operating costs.

Increased spending is also reported for environmental and energy projects by Canadian mills, similar to their U.S. counterparts. The largest such project is underway by Weyerhaeuser Canada Ltd. in Prince Albert, Sask. Weyerhaeuser is installing a new recovery boiler and converting the existing recovery boiler to a multi-fuel boiler, to provide many environmental benefits. The company is also investing in non-condensable gases and steam stripper projects for reduced environmental emissions.

There are currently three proposed machine installations active, but none are likely to be advanced in the current business climate. The most recent proposed machine installation added to the list is a possible installation by Tembec Inc. The company acquired the former Donohue Matane Inc. bleached chemithermechanical pulp mill in Matane, Que. in late 1999 and is considering investing up to C$100 million to install a new machine. The proposed lightweight coated (LWC) groundwood papers machine at a greenfield installation in Grande Alberta, Alta., is still undergoing provincial review.

About P&P’s Annual Survey. Now in its 36th year, Pulp & Paper and Pulp & Paper Project Report’s annual capital spending survey covers expansion and modernization projects at U.S. and Canadian mills. Unlike surveys that track spending by year, this survey covers spending by project. Dollar figures represent the total cost of reported projects and often include supporting equipment. The total cost of multi-year projects is assigned to the startup year and is not divided among the years of expenditure. Each survey primarily covers the three-year period, but projects with firm startup dates beyond that time—in this case, 2002—are also included.