Tough times for global forest, paper, packaging industry

Global forest, paper and paper-based packaging companies face another challenging year following a difficult 2005 for most businesses in the industry, according to PricewaterhouseCoopers ninth annual Global Forest, Paper and Packaging Industry Survey, released July 27. Return on capital employed (ROCE), a key measure of performance in this capital-intensive industry, fell to an average of 4.5 percent in 2005 from 5.3 percent in 2004 - far from the target of 10 to 12 percent.

The survey found that total global industry sales were up slightly in 2005 to US$340 billion from US$328 billion in 2004. However, operating profits were down by 11 percent to US$21.6 billion and ROCE fell to 4.5 percent from 5.3 percent in 2004.

Robert Barnden, global forest, paper & packaging leader, PricewaterhouseCoopers said: “2005 showed why it can be so difficult to make a decent return in the sector. The companies that succeed are ones who are innovative and develop methods to do more with less. Projections for 2006 remain challenging and innovation will again be the key to profitability.”

The economic factors which have impacted the industry most remain foreign exchange fluctuations, increased energy, transportation and raw materials costs, and the impact of the emerging market presence. Rising energy costs will remain a paramount concern for the industry for the second half of 2006.

Europe
European producers continued to face difficult market challenges in 2005 and continue to do so during 2006. Major issues affected key regional markets such as the industry-wide strike in Finland which contributed to almost a two billion US dollar reduction in earnings in Finland in 2005. During 2005 and continuing in 2006, most of the major producers began implementing capacity reductions, particularly the oldest and highest cost capacity, in order to establish a better balance between demand and supply.

Average sales growth was flat across the top 26 companies in the sector in 2005 against 2004 and return of capital investment fell from an average 4.7 percent in 2004 to 2.7 percent in 2005.

Robert Barnden, global forest, paper & packaging leader, PricewaterhouseCoopers, commented: “It’s worth noting that for the second year running no Europeans appear in the top performing global companies in terms of their ROCE. This is a clear indication of why most companies in Europe have embarked on or have in mind major restructuring projects.”

Six European companies bucked the trend of falling ROCE. Most notably Cartiere Burgo (Italy) and Ahlstrom (Finland) which both more than doubled their ROCE increase.

Despite the sub-optimal returns experienced across Europe, producers are continuing to increase investment above depreciation levels. New investment by European producers, on the whole, has been in modern capacity outside their home bases and by investing in emerging markets.

North America
US forest products producers in the PwC Top 100 – the top 100 companies in the 100 largest forest, paper and paper-based packaging companies in the world with publicly available data - made modest gains, with sales revenues up to US$12 billion in 2005 from US$123 billion the previous year. ROCE for these companies averaged 6.3 percent, up from 5.7 percent in 2004. There were 27 U.S. producers in the PricewaterhouseCoopers Top 100 and six of them achieved a ROCE of at least 10 percent, from the year before. Net income rose to US$5.0 billion in 2005, up from US$4.6 billion in 2004.

Housing sales and new builds in the US increased due to a favourable economy and interest rates. The strong housing market drove North American demand for lumber and structural panel products in 2005. The growth in manufacturing capacity, especially for lumber, coupled with improvements in rail transportation pushed product prices down in 2005 compared to 2004. Profits were diminished by higher raw materials and labour prices, energy prices and increased transportation costs.

Canadian producers had a disappointing year, with average ROCE dropping to 2.5 percent from 4.6 percent in 2004. Norbord was the most notable exception, ranked top company globally in terms of ROCE at 23.7 percent. The 11 Canadian-based producers surveyed posted total revenues of US$25 billion in 2005, an increase from US$24 billion in 2004. However, net income plunged almost US$1.3 billion for a loss of US$374 million. The reduction was equally contributed by reductions in operating earnings and increased non-operating expenses.

Capital investment as a percentage of depreciation fell from 2004 levels demonstrating the reduced confidence within the challenged Canadian industry and the anticipated difficulties in making adequate returns.

Other global highlights
The Latin America region once again held the top regional ROCE spot at 8.6 percent, down from 9.7 percent in 2004. Three Brazilian companies appeared in the top 12 global players in terms of ROCE – Aracruz, Votorantim and Klabin. Cash flow generated from operations was down across the industry by almost 20 percent to US$29 billion from US$36 billion in 2004. The volatility in the U.S. dollar impacted financial results.

In Japan, home to twelve of the PwC 100, the major companies have looked to investing in the nearby Chinese market in search of better growth prospects. This is a result little of change to average sales or ROCE which stayed around 3% when comparing the 2005 and 2004 figures.

The PwC 100 saw a newcomer in 2005 in China’s Nine Dragons Paper Holdings, which went public in 2006. China, with its phenomenal economic growth, continues to attract investment growth from Europe and Japan, and to a lesser extent, North America, in addition to high levels of investment from domestic producers. In 2006, interest remains strong in China with its fragmented industry and increasing demand for paper and wood products.