Japan's papermakers look on as the economy struggles

by Jim Kenny

Forecasting the fortunes of Japan's paper industry is easy, just look at the economy. For now though, the prospects don't look good

The small family-run petrol station that has been there on the corner for generations has been snapped up on the cheap by a large conglomerate. Lifelong job security in massive corporations is just a distant memory and even the golf club membership has been handed back. There's no doubt about it, things are changing in Japan.

On the back of several years of comparatively low growth, the world's second largest industrialized economy is now in recession. The most recent figures up to the end of June show that the economy contracted for the third quarter in a row - Japan's worst performance since records began in 1955. This represents an annualized GDP contraction of 3.3% and economic forecasters are now predicting a GDP fall of 1.7% for 1998.

Underlining the difficulties the country is facing is Toshiba's prediction that the electronics company would shortly incur its first loss in 48 years. Hitachi warned investors to expect its first losses in 50 years and Japan's economic planning agency voiced fears that the country could slip into a deflationary cycle.

Back in July, the Japan Paper Association (JPA) was among the business organizations calling for permanent tax cuts to boost the economy. There are two main types of tax in Japan. One is personal income tax, which goes up to a maximum of 65%, including national and regional taxes. The other is the corporate tax rate, which goes up to a maximum of 46%, including national and local taxes. The JPA lobbied for personal rates to be cut back to a maximum of 50%, and for corporate rate to be cut to 40%.

After much discussion, these cuts are set to come into force from next April. In the meantime though, the economy is still hurting and the yen has been seriously weakened by some of the measures the government and the Bank of Japan have taken to stimulate the economy. The Bank of Japan is easing monetary policy in an attempt to stimulate consumer confidence and revive the economy. But as a result, Japan's currency is finding it hard to stay much above Yen 140/US dollar.

All in all, 1998 has not been a fun year.

Paper prospects

As in other sectors, the country's economic plight has left papermakers struggling to deal with the consequences. In the wake of depressingly poor consumer demand, paper and board consumption has languished at pitiful levels. The lack of demand has been reflected in prices, which have seen significant declines in recent months. At the end of the second quarter this year, coated woodfrees were down by as much as 4-5% on the same period in 1997, corrugated medium was down 12% and linerboard prices sunk 15%. Added to that, price trends for the rest of the year looks less than positive. This is partly due to the economic crisis, but it is not helped by the fact that the country's paper industry has witnessed a series of large-scale capacity expansions in the last two years.

According to the JPA's president, Kiyoshi Sakai, there is still some room for hope though. "The overall economic situation is rather weak and paper prices have been getting lower and lower, but I don't know if I'd say that we have serious underlying problems," says Sakai. "Personally, I think the Japanese economy is being underestimated. Yes, people are very pessimistic and consumer confidence is very low, but once we see some positive signs, consumer confidence will go up as well and that will help push the paper industry up with it."

That may well be the case, but in the meantime papermakers have several other pressing problems to deal with. On the cost side of the equation for example, things are just as bad as they are for demand. Currency exchange rates have left many Japanese producers in a financial pickle. In a business that relies heavily on imported raw materials, a weak yen is likely to play havoc with costs. "For the paper industry, a weaker yen is disadvantageous," Sakai agrees. "It will help export-oriented industries, but if it continues to trade at such a low level, then there will be a lot of trade friction with other countries such as the USA. The yen has got to be stronger."

This view is echoed by Oji Paper's chairman, Takao Ohtsubo. "As you know, the paper industry is highly dependent on imported pulp, chips, oil etc, so a low yen leads to rapidly rising costs. And since we don't export much, we don't benefit from that," Ohtsubo explains. Oji would welcome a currency rate of Yen 110-120/US dollar, but expansionist monetary policies may keep the exchange rate below that level for some time yet.

According to the president of Nippon Paper Industries, Masao Kobayashi, if the yen remains in the doldrums, it could even attract extra domestic competition. "Traditionally, customers have always been very much domestic producer-oriented," says Kobayashi. "But because of the difficulties they're in, they're buying from overseas manufacturers even though they've got to compromise on quality."

Trade issues have long been a contentious topic with regard to Japan. For example, one of the most obvious solutions for paper producers hit by a weak currency would be to export their way out of their problems. But apart from the fact that almost every other papermaking group across Asia is attempting to do the same thing, Japanese producers are very reluctant to export larger volumes as this might exacerbate arguments over international trade links at a particularly sensitive time.

Several countries are already calling on Japan to reduce paper import tariffs ahead of the 2004 timetable previously agreed during global trade negotiations. Not only is the JPA against an early cut though, the association wants to see paper included in a broader discussion on trade tariffs. "It should be discussed as a wider manufacturing industry question," Sakai argues. "For example, if all the duties are lifted from the paper industry, that benefits the USA and Canada. But if you lift all the tariffs on electronics that benefits Japan, so it should be an all-round discussion."

It is unlikely that any of the countries involved in this debate will get what they are looking for, especially in light of Japan's economic uncertainties.

Tree tales

One area where Japan has been making great progress overseas is in the field of developing fiber supplies. Securing fiber for the industry has troubled Japanese papermakers for some time now, but it is being actively addressed. According to Sakai, Japanese paper groups now control 200,000 ha of planted forest outside the country and the plan is to double that figure by 2010. To ensure that this happens, the JPA has been involved in setting up a non-profit organization called the Japan Overseas Center for Pulpwood (JOCP).

The group was launched in March this year and is dedicated to finding suitable land for planting, determining the best species for the areas identified and promoting eco-friendly forest management techniques.

Long before JOCP started up though, Japanese papermakers have been focused on securing pulp supplies long into the future. As Kobayashi points out, Nippon has been aware that it had to do something for some time. "It's not exactly a change in strategy, more of an acceleration in the strategy of looking abroad." Brazil, New Zealand, Indonesia, Australia, South Africa and China have all been earmarked as likely candidates for companies such as Nippon as they aim to secure the pulp they need to run Japanese paper machines.

Oji too, has aggressive expansion plans for its plantation holdings abroad. Oji currently controls 50,000 ha of forest spread across Australia, New Zealand, Vietnam and Brazil, but it is looking to take that figure to 200,000 ha in the near future.

Joining up

Another result of the recent luckluster performance of many Japanese papermakers has been more consolidation. The sector has made some fairly large strides in this area already, such as the mergers that helped create the Oji Paper of today. But more merger and acquisition activity is anticipated, especially in the board sector where prices have suffered most as a result of industry fragmentation.

Fine paper and newsprint grades are reportedly the strongest growth areas in the medium term, but even here the potential for much more consumption remains limited. The JPA estimates that growth levels will reach 1.5% per annum. This is by no means an overly ambitious target, but Japan's economic outlook is such that it cannot be taken for granted.

As the fall-out from the Asian economic crisis spreads, there are a lot of nervous people out there. And in a nation that already has a reputation for high savings levels, low consumer confidence will place a severe brake on economic growth.

Rengo merges with Settsu to create Japan's largest boardmaker

The numbers are certainly impressive. Rengo will add its 793,000 tons/yr of containerboard capacity to Settsu's 1,132,000 tons/yr to take the combined group's domestic market share to 15.3%. At the same time, Settsu will bring its 301 million m/yr of corrugated board production to Rengo's considerable output of 1,736 million m/yr, creating a group with a combined market share of 15.2%.

The merger should help improve overcapacity levels in Japan's containerboard sector, hopefully helping prices in the process. But one of the main strengths of the merger as far as Rengo's managing director, Masao Yamaguchi, is concerned, lies in the fluting sector. Rengo is currently third in the market with an annual output of 327,000 tons/yr, while Settsu holds the number one spot with 613,000 tons/yr. "Together, we will produce 940,000 tons/yr, which is 25.4% of the total market and I think this is a major part of the merger," says Yamaguchi.

Working together

Due diligence is still ongoing. But what is clear is that there will be a lot of changes to come throughout both operations. "The very first problem we have to solve after the merger is restructuring the corrugated plants and mills," says Yamaguchi. "Some of the plant locations are very close together and both companies have subsidiaries and affiliates, so streamlining the production and distribution could take some time. Some things can change quickly, but others will take a few years."

Matchmakers

Settsu's recent financial performance and the fact that both companies shared the same banker - Sumitomo - helped drive the merger. But one of the main influences has been the general trend toward consolidation in the global corrugated sector. As Yamaguchi explains, "In the US, you have Smurfit and Stone, then there is Stora and Enso. It's just the same with the trend in the corrugated sector - huge mergers, not only in the USA or Europe, but all over the world."

Even in the middle of the process to bring two such large companies together, Rengo's MD foresees another major coupling as a distinct possibility. Whether Rengo/Settsu will be involved is open to question, but Yamaguchi believes the pace of consolidation will push change even further, possibly even to the extent of splitting open Japan's famed ownership hegemony. "My personal opinion is that I can see a US corrugated company or a European acquiring a Japanese corrugated producer in the future, not least because Japan is the world's number two corrugated consumer," he says.

For the moment though, the battle is more likely to be fought outside Japan as the world's larger players stake their claims in Asia's markets, with China the big prize. "Globalization definitely will happen," says Yamaguchi. "Actually, even at this stage we have six corrugated plants and a joint venture corrugating materials mill in China. SCA, Weyerhaeuser and Smurfit are already there, so it's very competitive."

Life is also proving competitive in Japan. The government's drive to boost paper recycling rates has helped push wastepaper from Yen 15/kg in 1996 down to Yen 9/kg today. But the paper companies have managed to hold on to little of the benefits from lower raw material costs. "There is an imbalance that has been created by increasing collection and flat consumption," Yamaguchi explains. "But if you look at the price for containerboard two years ago, it was about Yen 69/kg, while it's now about Yen 63/kg at today's prices. It's a highly competitive market, so we can't keep a hold of that extra saving."

Looking ahead

Rengo's current projects include a new plant being built in Shanghai and plans to establish a joint venture in Guangdong. To date, Rengo has a presence in six Asian countries and has developed its overseas interests through joint venture partnerships. Closer to home, the group expects to complete a new 7.0 million m/month corrugated plant in Hokkaido at the end of this year. And for the future, Rengo is targeting the flexible packaging business in the wake of a Yen 6.5 billion acquisition earlier this year.

For the future though, the corrugated business is invariably tied to GDP growth. So if the Japan's economy lurches further into recession as many fear, Rengo/Settsu could begin corporate life in very challenging circumstances.