Troubling Times in the European CWF Market

A FISHER
EXCLUSIVE
ANALYSIS
MARCH 2014
Troubling Times in the
European CWF Market
By Tedd Powers, Senior Consultant, Fisher International
The coated woodfree (CWF) market in Europe is ailing and the
future does not look very bright. After years of declining demand
without the corresponding reduction in production capacity,
European coated paper makers have grossly excessive capacity
and face a severe profitability crisis. In a recent earnings
statement, Sappi CEO Ralph Boëttger said, “Demand in Europe is
expected to remain subdued. Input costs remain high and we do
not expect any price increases in our major paper grades…industry
dynamics won’t improve without intervention.” We believe the
intervention Mr. Boëttger refers to is the need to reduce capacity.
The severity of the crisis requires drastic action. But drastic action
usually means costly action; and which of the producers can afford
to shoulder the cost? Taking decisive action could be costly for
sure, but failure to take decisive action will be fatal for some.
One major impediment to decisive action is the fragmented nature
of the European CWF market. As the FisherSolve™ graph (Figure
1) illustrates, none of the participants approach the 30% share we
find required for effective leadership and discipline.
2
European CWF Market Share
Total = 9,761,712 FMT
™
Source: FisherSolve © 2014 Fisher International, Inc.
Figure 1: The fragmented European CWF market currently operating at 80%
capacity.
With current operating rates stuck in the low 80’s, the need for
capacity reduction is obvious. The question is whose capacity and
when? Without doubt, production capacity will always seek a home.
Sometimes that home is a temporary shelter – perhaps through
increased exports. Sometimes the home is subsidized through
lower prices in an attempt to buy shelter. But sometimes the home
is completely dysfunctional and wholly unhealthy for everyone who
lives there. In that case, significant intervention is required.
So if you accept the idea that significant intervention is required,
what form could it take and how might it happen? Referring back to
Figure 1, we see the challenge presented by fragmented markets
such as this one. None of the top five participants–Sappi, UPM,
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FISHER
EXCLUSIVE
Stora Enso, Lecta, or Burgo–could possibly close enough capacity
to effectively solve the oversupply problem alone without
significantly diminishing their position. Smaller players are not good
candidates for voluntary capacity reduction because closing even
one machine typically represents an unacceptably high percentage
of their production. So, short of a series of painful bankruptcies, a
ANALYSIS
Troubling Times in the European CWF Market
3
deliberate realignment must come in some form of consolidation
among the top five producers.
Such consolidation and realignment would have to create an entity
large enough to rationalize capacity at a cost that was justified by
the resulting improvement in market dynamics. Given that demand
for coated papers continues to shrink, there would have to be
enough consolidation not just for now, but also for the near and
medium-terms. But how can we know which combination makes
sense? An analysis using FisherSolve suggests a range of options
available. We’ll show one such scenario to illustrate that a solution
is possible.
This approach starts with a look at costs. The Benchmark Cost
curve (Figure 2) demonstrates that among the top five companies
making CWF, Stora Enso, Burgo and Sappi have the lowest costs.
European CWF Producers’ Cost Analysis
Burgo
Sappi
Lecta
UPM
Cost, EUR per FMT
Stora Enso
Cumulative Production, FMT per Year (x1,000,000)
™
Source: FisherSolve © 2014 Fisher International, Inc.
Figure 2: FisherSolve cost curve identifies major producers and their cost positions.
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Using the M&A Scenario Planning tool in FisherSolve, we can
simulate the effects of a combination of these three companies. In
Figure 3, we see that an entity resulting from the combination of
Stora Enso, Burgo, and Sappi’s coated papers businesses would
have enough excess capacity to provide meaningful rationalization
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Troubling Times in the European CWF Market
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without surrendering its ability to exercise market leadership in the
present and medium-term future.
M&A Scenario for European CWF Market
at Current Production
Total = 9,761,712 FMT
™
Source: FisherSolve © 2014 Fisher International, Inc.
Figure 3: European CWF market shares after consolidation scenario but before
closures (at current production rates).
Now that we have created this market leading company, we need
to intelligently rationalize capacity. An initial instinct might lead us to
identify machines for closure that today have the highest costs. But
we can and should look beyond only today’s cost to evaluate the
long-term competiveness of a machine or mill. FisherSolve’s
Benchmark Viability Index considers a range of metrics including
cost competitiveness, capital requirements, asset quality, scale,
grade health, and several other factors; the higher the Viability
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ANALYSIS
Index score, the greater the risk. Moreover, our new Benchmark
Carbon product provides subscribers with insight into each asset’s
greenhouse gas emissions. The bubble graph (Figure 4) combines
these measures to bring clarity to the question of which mills might
be candidates for closure. Considerations of logistics, product mix,
machine capabilities, and other factors are also analyzed with
FisherSolve to help refine the selections.
Troubling Times in the European CWF Market
5
Stora-Sappi-Burgo CWF Mill Comparison
Site Viability Index
Candidates for closure in this quadrant…
higher cost, higher risk, significant CO2/ton
One half of the
new company’s
production is
below this cost
One half of the new company’s
production is below this viability index
Site Mfg Cash Cost/ton EUR
Bubble size = CO2/ton emission
™
Source: FisherSolve © 2014 Fisher International, Inc.
Figure 4: FisherSolve ranks mills by a variety of metrics to identify those at risk.
In this scenario, the mills and machines selected for closure yield
the new market landscape shown in Figure 5. Realignment and
rationalization closes more than 1.3 million tonnes of capacity,
allowing healthier operating rates in the mid 90’s. Moreover, the
new company is a low-cost producer capable of leading and
disciplining the market to sustainable health and improved margins
if pricing improved (Figure 6).
But would it be financially feasible to create such a company and
take the painful actions necessary to solve the European industry’s
overcapacity problem? The costs of realignment and rationalization
would be significant and there would certainly be substantial risk
involved. However, our financial analysis suggests that even
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conservative estimates of improvements in market dynamics could
deliver an attractive payback given a transaction with an
appropriate structure. (We encourage anyone with an interest in
understanding the matter further to contact the Fisher International
consulting team.)
ANALYSIS
Troubling Times in the European CWF Market
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M&A Scenario for European CWF Market
at Adjusted Production
™
Source: FisherSolve © 2014 Fisher International, Inc.
Figure 5: European CWF market shares after consolidation and closure scenarios
(operating at approximately 95% capacity).
Cost, EUR per FMT
European CWF Producers’ Cost Analysis
after M&A Closure Scenario
Cumulative Production, FMT per Year (x1,000,000)
™
Source: FisherSolve © 2014 Fisher International, Inc.
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Figure 6: FisherSolve's cost benchmarking shows the cost position of players after
the consolidation scenario.
FISHER
EXCLUSIVE
ANALYSIS
Troubling Times in the European CWF Market
7
The ancient Greek physician Hippocrates is reported to have said,
"For extreme diseases, extreme methods of cure are most
suitable.” The CWF market in Europe is ailing and calls for
significant intervention. A diagnosis of the situation and tests of
various treatments suggest a best possible outcome which, given
the seriousness of the situation, may be one of the only ones.
Tedd Powers is a Senior Consultant at Fisher International. He can
be reached at [email protected]
About FisherSolve™
FisherSolve is a market analysis tool that supports data-driven decision making in the pulp
and paper industry. It contains a powerful proprietary database that accurately describes
every pulp and paper mill in the world (making 50+ TPD) with information about each mill
and machine’s scale, asset quality, cost-of-production, competitiveness, market shares,
and much more. FisherSolve is used by the world’s major pulp and paper producers,
suppliers, investors, and buyers to bring analytic discipline to their strategic and tactical
business practices.
Fisher International, Inc.
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So. Norwalk, CT 06854 USA
+1 203-854-5390
www.fisheri.com
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ANALYSIS
Troubling Times in the European CWF Market