Stable Condition

Features - Paper

North American forest products companies maintain a stable outlook despite economic risks and volatile costs.

October 31, 2012
Tobias F. Crabtree, CFA

A sluggish recovery in North America, recession in Europe and slowing growth in China are testing the paper and forest products industry. In addition, newsprint and coated and uncoated paper manufacturers in mature markets, such as the United States, continue to face declining demand as consumers shift to electronic media. Volatile wood, recycled fiber and petroleum-based energy and transportation costs are additional sources of significant uncertainty and can cause substantial fluctuations in profits from one quarter to the next.

North American forest and paper products companies will likely try to respond to these challenges by curtailing capacity to match demand, trimming costs and increasing vertical integration while maintaining sufficient cash and financial flexibility. Many also continue to invest in growing regions, such as Asia and Latin America. While Standard & Poor’s Ratings Services maintains a stable outlook on the industry as a whole, we expect some companies, particularly those we rate speculative grade, to be more vulnerable to the economic and industry-specific risks. Additionally:

  • We expect low growth for North American forest products firms as a result of global economic uncertainty.
  • Our rating outlook on the paper industry is stable overall, but our forecasts vary for demand, supply and pricing for the pulp, paper and packaging segments.
  • In general, we anticipate flat demand for most of the packaging segments and continued declines in demand for paper and newsprint, while pulp and tissue paper manufacturers are benefiting from population growth and expanding economies in Asia and Latin America.
  • Companies with good financial health are better positioned to weather any economic shocks, such as a U.S. recession or euro zone crisis, in our view.

Uncertain economy, dampened demand

Standard & Poor’s economists expect economic growth to be sluggish in North America, with U.S. real GDP (gross domestic product) increasing 2.2 percent in 2012 and 1.8 percent in 2013. We expect Europe, on the other hand, to remain in a recession through 2013. We anticipate that China’s economy will continue growing, albeit at a slower rate than in previous years.

Based on this economic outlook, we expect demand to vary across the different North American forest and paper products segments. In general, we anticipate flat demand for most of the packaging segments and continued declines in demand for paper and newsprint. One bright spot for growth has been pulp and tissue paper manufacturers, which are benefiting from population growth and expanding economies in Asia and Latin America. Overall, however, demand conditions for 2013 look a lot like they did in 2012, with more causes for concern than optimism.

Consolidation & supply discipline
We believe subsectors, such as containerboard and paper producers, that have consolidated significantly and, thereby, improved their competitive positions, are well-positioned to withstand slower growth prospects. More disciplined production is likely key to improve pricing for containerboard manufacturers and contributes to our view that profitability will modestly increase for these companies in 2013.

For the uncoated and coated paper segments, capacity closures in 2011 and 2012 have largely kept pace with declining demand. For 2013, uncertain economic conditions will likely prevent a significant increase in coated paper prices absent additional supply cuts and will likely constrain earnings growth for the largest producers—NewPage Corp. and Verso Paper Holdings LLC—as a result.

Uncoated freesheet paper production is highly consolidated in North America, with International Paper Co., Domtar Corp. and Boise Paper Holdings LLC holding 65 percent of total capacity. Still, competition from Asian imports, coupled with ongoing demand declines in the low single-digit percentages, leads us to anticipate flat to slightly lower uncoated freesheet prices in 2013.

We expect high current operating rates for newsprint producers to moderate in 2013, as further demand declines prevent companies from raising prices. As a result, we see limited upside for newsprint prices in 2013 versus 2012.

Tissue papers will likely be the only segment that adds capacity as a result of growing demand, largely because of population growth—for example, companies such as Clearwater Paper Corp. and Georgia-Pacific LLC are expanding. Global pulp prices are likely to remain weak through 2013, given capacity additions in Latin America and slowing growth in China. Profitability for the major North American pulp producers is likely to remain volatile and below the recent peaks of 2010 and 2011.

Cost management

Under our current global economic growth outlook, we expect that cost inflation—for wood and recycled fiber, pulp, energy and chemicals—will remain modest and will not have a significant impact on profit margins for forest products companies in 2013. We forecast no substantial change in oil- and petroleum-related input costs compared with 2011’s average given the low growth prospects in the U.S. and slowing growth in Asia, though they’ll likely remain volatile from one month to the next. We expect natural gas costs to remain low given increased supply from shale gas. A recovery in the U.S. housing market supports our view that costs for wood chips (a byproduct of sawmills) will moderate, which could reduce costs for corrugated products manufacturers, such as Longview Fibre Paper and Packaging Inc. We estimate that prices for pulp, a key resource for paper and paperboard producers, will remain below 2010’s peak levels for the next year. We expect recycled fiber prices, which moderated in 2012, to remain volatile, fluctuating with changes in demand from China. Still, we anticipate higher recycled fiber prices, on average, over the upcoming years as a result of continued expansion of recycled fiber-based paper and paperboard production in China.

Cost-effective procurement of fiber and energy remains paramount, especially when a weak economy is likely to limit most producers’ ability to pass through any sudden rise in input costs to their customers. Most large forest products companies across North America benefit from some degree of vertical integration (they manufacture their own pulp or energy) and continue to trim costs to lessen their use of raw materials and mitigate inflation. Still, we believe most small to midsize forest and paper producers that rely on external sources for fiber and energy are particularly vulnerable to a surge in petroleum-based or recycled-fiber input costs—like the one that occurred in 2011.

Stronger but still vulnerable

Since 2008, North American forest products companies have been working to restore profitability by significantly reducing costs, preserving cash, maintaining strong balance sheets and, in certain instances, reorganizing through bankruptcy. Still, financial strength across the sector varies, with most companies falling into the speculative-grade rating category (‘BB+’ or lower), which reflects the significant industry, business and financial risks these companies are facing. Only nine issuers, or less than 30 percent of the forest products companies we rate, are in the investment-grade category, which reflects their better business risk assessments and stronger financial risk profiles.

We believe the issuers we rate speculative grade, especially those in the lowest rating categories (‘B’ or lower), are most at risk to the challenges facing the overall industry in 2013. The coated paper segment, in particular, continues to suffer significant financial stress—for example, NewPage, the largest coated paper manufacturer in North America, continues to operate under bankruptcy protection, while the second-largest producer, Verso Paper, has a significant debt burden.

Stable, despite hurdles

Our credit outlook, which incorporates our financial performance expectations, is stable overall for North American forest and paper products companies over the next 12 to 18 months. Of these issuers, 80 percent currently maintain stable rating outlooks, including all nine companies we rate investment grade (‘BBB-’ or higher). However, our expectations for sluggish U.S. economic growth and a weak, albeit improving, housing market will likely curb earnings growth, prevent a significant improvement in financial credit metrics and, ultimately, constrain any improvement in ratings. However, we believe significant downgrades are not likely absent macroeconomic shocks or a stalled recovery in the housing markets. Most companies maintain strong liquidity positions, given economic uncertainty, and we expect continued good cash flow and minimal near-term refinancing risks following numerous refinancing transactions over the past two years.

We view macroeconomic risks, including a U.S. recession or potential contagion from the euro zone sovereign debt crisis, as the primary risks to our outlook, as opposed to company-specific risks, such as mergers and acquisitions (M&A) or increased shareholder rewards. We expect M&A to moderate over the next year, following several large transactions that led to consolidation in the paper-based packaging segment over the past 18 months. More aggressive financial policies, such as large debt-financed acquisitions or shareholder rewards, could cause us to take negative rating actions. Still, we view this as unlikely given our outlook for weak economic growth.

Today, we believe the North American forest products companies, generally, fall into financial “haves” and “have nots.” We expect the financially strongest companies (those we rate investment grade)—such as Georgia-Pacific, International Paper, Packaging Corp. of America, Rock-Tenn Co., and MeadWestvaco Corp.—to be best able to invest in operations to sustain their market positions, trim costs, expand outside of mature markets and preserve cash and liquidity through an uncertain economy in 2013. Those companies with weaker financial profiles will likely put investment opportunities and growth initiatives on hold until the recovery in North America firms up. Most of the financially weak companies have refinanced or restructured debt obligations in the past few years, however, making them more able to withstand an uncertain 2013.

The author is director, forest and paper products, at Standard & Poor’s in New York City. He can be contacted at 212-438-6503 or at