It’s one step forward, two steps back for Sappi, South Africa’s longest-listed paper producer. This quarter, it produced a stomach-churning loss of $413m, thanks to $289m worth of “special items”. Sappi’s shares sank on the news and the stock has now given up over 40% year to date. The FM spoke to CEO Steve Binnie.
The ratios are awful: on a 1% drop in revenue, your earnings halved to $52m for the March quarter, before special items. Is it the case that everything is moving against you right now?
Ja, we’ve got a lot of headwinds simultaneously. The biggest reason for the drop is in South Africa. Our main product, dissolving pulp, has been under pressure from a selling price perspective. It actually did start to improve towards the end [of the quarter], but for most of the time, it was more than $100 lower than a year ago, and we sell over 300,000t in a quarter, so it’s a big impact. The other massive factor for us is the rand; we’re a rand producer and we sell in dollars. We’re a business that still uses a lot of Eskom; double-digit increases over the years accumulate. Then there’s the infrastructure, the rail, the ports … not optimal, and that all adds to our cost. And we’re a massive user of diesel to get the timber to the mills. I know I’m ranting, but that’s a fact, so when the rand strengthens against the dollar, it’s just awful for South African exporters like us.
But is it just in South Africa where the problems lie? Because the impairment you took (of $276m) related to the European graphic paper business?
You’re right — it’s not just South Africa. Funnily enough, the actual graphic segment margins were OK; we were going to take the writedown at some point anyway, but the accounting rules dictate that you have to do a valuation at the end of each quarter, so that’s why it was triggered now. In the US we are ramping up and the volumes are going well. The problem — and I know I’m giving you all my problems — is that the prices of packaging across the globe have been under pressure. So although volumes were improving, selling prices were down about $100 quarter on quarter. Packaging and pulp are growing [categories], but add in low selling prices and all the turmoil around global macro tensions and fuel prices. We use a number of chemicals in the manufacturing process, like sulphur and latex, and the prices of these have just gone through the roof. Some of them are trapped on ships behind the Hormuz strait. So all these things combined put a lot of pressure on us.
The other massive factor for us is the rand; we’re a rand producer and we sell in dollars
— Steve Binnie
Everyone keeps looking for the growth story for Sappi — and Mondi. One would have thought the explosion in e-commerce should have been a huge boon to anyone involved in packaging, and it just never materialises. What factors have to be present for it to happen?
The interesting thing is that you are getting the demand growth. Pulp is growing at 5% per year. Packaging specifically grows at about 2% a year globally. But the problem, especially in Europe, is that a lot of the graphic paper guys converted their capacity away from graphic paper into packaging. So it became a market balance issue and there’s a lot of excess capacity in Europe and, to a lesser extent, in the US. That’s what’s impacting pricing. Then there’s the bigger story of consumer demand. And the ability of FMCG [fast-moving consumer goods] companies to absorb higher packaging costs has been constrained. I think the demand side is OK. Lastly, I think the shift away from plastics towards paper maybe has not been as strong as everyone thought it would be five or six years ago. It costs a lot of money to shift to a greener economy, and with all the pressure businesses have been under, there’s been less capex spent on converting to a greener solution.
In terms of taking out excess capacity, you’ve proposed a merger with German group UPM to bring together your graphics paper businesses, but the EU Commission now wants to do an in-depth investigation into the competition aspects of the deal. Do you think they’ll take a hard line or a benign one?
Look, they are more pragmatic than they used to be and our advisers think we’ve got a strong case — for all the reasons we’ve described. They want industry champions in Europe and they know there’s all this capacity and we’re the two biggest players, and if they enable this to happen it does build a more resilient, globally competitive business.
The last time we spoke your debt covenant ratios were about 4 times. You’re now at 6.1, but your bankers seem to be OK with this. Are they really?
They know the industry, they know the business well. The actual amount of debt didn’t change. They know these are crazy market conditions at the moment and they believe — like us — that a recovery is going to come and those leverage ratios will improve into next year.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.