European paper companies could safeguard growth and profitability through diversification

Submitted by: The Two Sides Team January 29, 2013

Due to declining paper demand, non-paper operations, emerging markets are key to long-term growth according to Moody’s report.Amidst declining paper volumes, European paper and forest product companies could restore their long-term profitability, and in doing so strengthen their credit profiles, by diversifying away from the paper market, says Moody’s Investors Service in a Special Comment report published this week.

The new report, entitled “European Paper and Forest Product Companies: Diversification Away from European Paper Market Is Key to Growth”, is now available on www.moodys.com.

“Most rated companies have headroom within their respective ratings category to accommodate some deterioration in their credit metrics due to weakening demand for paper in Europe,” says Anke Rindermann, an Assistant Vice President – Analyst in Moody’s Corporate Finance Group and author of the report. “Nevertheless, non-paper operations and emerging markets will remain key long-term growth drivers for European paper companies.”

“In the face of a deteriorating profitability, some operators, such as Stora Enso Oyj (Ba2 negative), Metsä Board Corporation (B3 positive) and Sappi Limited (Ba3 positive), are diversifying their operations away from the mature European paper market by moving into related product areas with higher margins ,” explains Ms. Rindermann. “Meanwhile, other companies, such as UPM-Kymmene, rated Ba1 stable, are seeking to expand their geographical reach by investing in markets with better growth prospects, particularly in Asia.” Moody’s would expect these trends to continue in 2013.

This diversification comes against the backdrop of persistent macroeconomic weakness in the euro area and the structural decline in demand for paper, owing to the ongoing shift to digital media. These factors are creating a widening supply-demand gap at a time when producers are facing elevated input costs and have limited pricing power. In such an environment, pure paper players with high exposure to the European paper market, such as Norske Skogindustrier ASA (Caa1 stable) and Lecta S.A. (B1 stable), are the most vulnerable.

While unlikely to be sufficient to safeguard long-term profitability, most if not all producers have made substantial efforts to cut costs by closing excess capacity and improving internal efficiencies. In the case of Metsä Board, this could lead Moody’s to upgrade the company’s rating if its cost-cutting efforts result in an improvement in operating performance over the next couple of quarters, hence the positive outlook assigned to the rating. Moody’s would expect producers to take further steps to rationalise their cost bases, although the associated costs could dent their short-term profitability.

Input costs are likely to remain high, although pulp prices may ease in 2013 due to additional production capacity coming on stream in South America. As the pricing power of paper producers in Europe remains weak, rated companies with a high degree of vertical integration into low-cost fibre and energy, such as Mondi Plc (Baa3 stable) and UPM, are likely to fare better.

Stora Enso’s rating is under pressure because its operating profitability has weakened in Europe at a time when it is investing heavily overseas. But, if these projects are executed on time and within budget, Moody’s would expect them to enhance Stora Enso’s credit profile from 2015 onwards.

This article appeared on the Industry Intelligence Inc website.

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