Players Begin to Reap the Benefits of Transformational Investments

22 September 2014

For the remainder of 2014 and in 2015, Moodys expects players that have repositioned or broadened their business profiles in recent years, such as Metsä Board, Mondi, Sappi, Stora Enso and UPM, to maintain or even improve their profitability. This is because these companies have made sizeable investments into related segments with higher margins and more consistent levels of profitability, such as specialty paper, paper packaging, liquid packaging, chemical cellulose, and/or pursued fixed cost improvement programmes related to their legacy paper operations. Moodys recently changed their industry outlook for European paper and forest product companies to stable from negative. This reflects expectation for operating earnings growth of 3%-4% over the next 12 to 18 months as positive earnings from packaging operations of rated companies outweigh those from paper operations, which continue to face secular declines.

Although the European paper industry is trying to arrest the effects of the structural decline in demand mainly through in-house
capacity curtailments, supply continues to outstrip demand. For example, most market constituents expect that demand will
continue to fall by 5% a year across graphic paper grades owing to the ongoing shift to digital media, necessitating further capacity
cuts to halt current price declines. Consolidation in the fragmented European paper industry, if it involves the closure of less efficient
capacity, would be a supportive factor for the longer-term viability of the industry.

Substantial new capacity, will enter production between 2014 and 2016, adding approximately 8 million tonnes to global pulp
capacity. Inventory management across the fragmented global pulp industry is key to balancing supply and demand.

In the short term, players that are non- or only partially integrated, such as Norske Skog and Lecta, are likely to benefit from declining costs as market pulp prices decrease as global supply outpaces demand, although lower pulp prices may eventually lead to additional pressure on paper prices, eliminating this temporary advantage. Meanwhile, producers that are long in pulp and sell excess supplies i n themarket could suffer. In the long term, expect growing demand for pulp in Asian to help rebalance global pulp markets and stabilise prices.

Matthew Rogerson,

Editor



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