Ratings Agency Sees Difficulties in European Paper Industry

Fitch Ratings, London, says that the credit outlook for the European paper and forest products (EPFP) sector remains negative, with the impact of the global downturn is still outweighing the effects of counter recessionary measures by Fitch’s rated EPFP issuers.

“Demand erosion is outstripping the benefits of capacity closures carried out by European companies in 2008,” says Myriam Affri, director in Fitch’s Industrials Group. “Approximately 3.3 million [tonnes] of graphic paper and 0.9 million [tonnes] of packaging capacity were taken out of the market in a bid to restore market balance and pricing power. However, after showing signs of recovery in early 2009, prices in most grades appear to be slipping back and additional capacity is again being removed from the market through voluntary curtailments and/or planned or forced permanent closures,” she adds.

Two of Fitch’s three paper-sector rated companies—Finland’s Stora Enso Oyj (BB+/B/Negative) and UPM-Kymmene Oyj (BB+/B/Negative)—have a negative rating outlook, reflecting the agency’s expectation that market conditions will continue to put pressure on the ratings. The negative outlook also extends to Fitch’s portfolio of private shadow-rated leveraged EPFP issuers.

For the packaging sector, Fitch comments that while the corrugated and containerboard markets have softened to date, driven by declining industrial demand, exposure to resilient end markets (such as food and beverages) has provided some level of support.

Fitch observes that new containerboard capacity coming on stream during 2009 and 2010 in Europe (Mondi, Prowell, Hamburger) “poses the biggest risk for the sector as, against the existing slump in demand, this new supply will disrupt the market balance, and result in a further weakening in prices and margin compression.”

Despite these factors, Fitch says that Smurfit Kappa Group plc’s (BB/Stable) credit metrics and business profile “provide sufficient headroom to accommodate the challenges ahead.” Its ratings and outlook were affirmed in June 2009.

More positively, input cost inflation and unfavourable foreign exchange trends are easing for the European paper industry. Energy, transportation and chemicals costs are retreating, in line with crude oil prices. Pulp prices have also fallen from the highs of 2008, although Fitch notes there has been a recovery in the first half of 2009 as aggressive curtailments and revived demand from China have pushed prices up. Lower producer activity levels are also resulting in positive working capital movements and providing cash flow relief.

Fitch’s rating definitions and the terms of use of such ratings are available on its Web site at www.fitchratings.com.