Pulp & Paper: Industry Evolution Continues

Cost increases, driven in part by increased energy costs, continue to be the biggest influence on the North American pulp and paper industry, according to Peter Frandina, senior manager, Accenture Forest Products.

The main question pulp and paper companies have had to ask themselves in the last few years is “how do I stay competitive and reduce my costs when I can’t push the cost increases onto

the market,” Frandina pointed out. “When you can’t pass it on, you have to look at internal efficiencies and profits,” he said.

The answer in part lies with capital expenditures, which Frandina said the industry continues to cut and peg to depreciation. A decade ago, the ratio of expenditures to depreciation was about 1 to 1.5, but that number today stands at about 1:1 as the industry continues to find ways to use “internal financial levers to balance performance.”

However, the industry is headed toward “hitting the wall,” Frandina said, which will happen in the near future. At that point, companies will need to begin spending to replace aged equipment or face taking equipment off-line.

The answer to cost problems also lies with changing strategies, Frandina said. For example, diversification is no longer a hot strategy.

 “The model where you have 10 to 15 companies or divisions doing different things in paper and pulp is no longer with us,” Frandina pointed out. Instead, market concentration, specialization into one or two core segments and shedding of assets that don’t fit into those segments has become the norm in the market.

Meanwhile, capacity rationalization, which has been aggressive in the last couple of years, is “still not keeping up with the demands,” and private equity is playing a short-term role in the industry. Private equity’s share of paper and board capacity within North America, for example, has grown from about 4% in 2000 to about 25% in 2006, he said.

“The bad news is, PE keeps some bad assets on the books,” Frandina said. The good news with private equity, however, is that PE owners that keep in the market look less at quarterly earnings and more at sustainable capabilities—what will be profitable over the long run.

One development that the paper and pulp industry, which relies heavily on equipment and transportation, is paying strict attention to is energy management—facilities are looking at better ways to predict what energy will cost as it is being used instead of waiting until the end of the month to pay utility bills. What they hope to do is be able to slow production or even shut off parts of operations when prices get to a certain point. They are also looking at alternative fuels for running some equipment, and at the capacity for switching fuels when one type gets too expensive.

“Real-time costing [for energy costs] is a very hot topic right now,” Frandina said.

The biggest drivers going forward will be changes in who buys the paper and pulp and how they use it, Frandina said. For example, print advertising is flat and even declining slightly in some areas helped along by electronic technologies as well as lower publication volumes. At the same time, magazines and book publishers are pushing for lighter-weight paper to save on postage and lower-quality coatings, and high-end brochures and annual reports are starting to go electronic. Meanwhile, smaller niche printing companies are springing up, producing quick turnaround, small-volume jobs.

Internationally, Frandina called China “the big gorilla” and reported that three out of the top five machines in the world for printing have been put in place in that country in recent years, so capacity there is definitely exceeding demand. There are also other places that have an advantage, such as Brazil, where trees are easy to grow. While U.S. producers are getting nervous about foreign competition, “there is fortunately a very small light at the end of the tunnel” in the form of anti-dumping legislation, which the U.S. government is now taking seriously, at least for the coated and sheeted sectors, Frandina said.

FORECAST: The ratio of capital expenditures to depreciation will stay about the same in the short term, flattening out in the next three to five years and not seeing an uptick until after that. The U.S. will look for more ways to keep global competition out or go overseas for supplies and business. Short-lived private equity investment will fizzle out and investors will look more at the long term.