Fitch Ratings said that it expects shipments and earnings for the paper and forest industry to show some recovery in 2010, contributing to a modestly improved credit profile for the sector.
Capacity rationalizations and cost deflation were the highlights of earnings releases in 2009, discounting the money that poured into the paper industry from U.S. alternative fuel tax credits. Sales volumes and prices both shrunk causing top-line revenues to plummet. By historical standards demand will still be weak, Fitch said.
"Paper producers should see better volumes in some grades next year but will have to raise prices to protect margins from cost inflation," said Dennis Ruggles, Director at Fitch. "With no significant forces pushing revenues, there will only be modest improvements in leverage metrics."
North American Paper
Breaking it down by grade, trends in uncoated freesheet and coated mechanical papers appear to be stabilizing. Although year-over-year comparisons of monthly and year-to-date shipment data are still in negative territory, the pace of decline has reversed. More ambiguous are trends in coated freesheet and uncoated mechanical papers, the product of lower advertising budgets, choices where those dollars are being spent, and declining newspaper circulations. Trends favor higher volumes in 2010 for uncoated freesheet and coated mechanical papers whereas coated freesheet and uncoated mechanical papers could face another hardship year.
Amid tepid paper demand, margins are being squeezed by the costs for pulp. Pulp prices have increased six times in as many months and are now around $175/tonne higher, up from $605/tonne for southern bleached softwood kraft. The demand pulling pulp prices is not North American but Chinese. North American pulp consumption, as well as European, is down around 14% year-to-date, but the demand from China is much higher and accounts for 22% of world pulp consumption. This cost factor is pushing paper prices higher whereas other costs, i.e. caustic soda and energy, have probably seen their limits of deflation with the costs for calcium carbonate, kaolin and titanium dioxide already rising.
On balance, better volumes will drive a modest improvement in earnings for select grades with margins coming under pressure, Fitch said in its report.
Containerboard and Paperboard
U.S. corrugated box shipments, measured in rolling 12-month periods to smooth seasonality, have been declining ever since April 2007. The pace of decline seemed to turn last August. Containerboard production is still soft, down 12% year-over-year through last September, with mills operating at 83% of capacity. Exports have been holding at just over 9% of production, courtesy of the weak U.S. dollar, Fitch noted.
Mirroring the rise in feedstock pulp prices, recycled paper prices (which feed 27% of U.S. containerboard capacity) have doubled since the first quarter of 2009, also due to Chinese demand. To preserve operating margins the industry has announced a first-quarter price increase which will likely set the pattern for 2010 as latex and energy join rising fiber costs.
Fitch is not expecting a significant improvement in North American corrugated volumes, but overall operating profits should be flat to modestly higher.
Paperboard by virtue of its linkage to disposable consumer products has been more resilient than corrugated boxes in this recession. Growth in paperboard volumes will probably trail that of corrugated packaging in 2010; it did not fall as far, but it will experience the same cost pressures.
The two significant forces in 2009 that helped sustain the North American paper and packaging industry were the return of the high yield markets and the unintended black liquor energy tax credit, Fitch said. The former allowed companies to refinance problematic bank debt and near term maturing bonds. The latter will have added an estimated $7 billion to the industry's cash coffers (not to be repeated in 2010), restoring badly needed liquidity and allowing companies to reduce debt. In concert these two forces have probably prevented a few additional bankruptcies.
With earnings pressure moderating some in 2010, liquidity should become less of an issue for creditors. The brakes will still be on capital expansion so leverage metrics should improve modestly.
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