Q: Why are paper companies doing so poorly on the stock market, and how are converters affected?

Michael J. Ducey, Consulting Technical Editor, 415/928-7297, paperfo@earthlink.net -- Converting Magazine, 11/1/2000

A: The Wall Street gang has not been kind to paper companies this year. The Philadelphia Forest Products Index is down more than 30%, and many companies have lost half their value. Since many employees have some or all of their retirement savings in company stock, anxiety is running high and patience is running out. Board members, directors and top managers are under pressure from fund managers, banks and shareholders for a return on their money.

One factor plaguing the industry is simple economics-there is no interest in buying paper-company stocks. Worldwide consolidation and restructuring have not changed overcapacity and global competition, though prices have firmed and inventories have been balanced. Paper profits will be lower because of cost increases in pulp, secondary fiber, energy and marketing, not to mention merger costs and lower production.

How might paper executives boost stock values? There are likely to be a few more consolidations, perhaps producing one or two worldwide blockbuster combinations and establishing a new world order of paper shipments (like the oil companies). The trans-ocean mergers have brought about some order in brown and white board grades, but coated recycled board and uncoated kraft are still very competitive markets. Firm pricing in a slowing economy and reduced production certainly indicate collaboration of newly merged companies.

Another way to attract investment from money managers is higher yields. The paper companies are likely to start raising dividends to distinguish themselves. Price-to-earnings ratios and other traditional methods of valuation do not seem to matter much any more, and capital appreciation will be limited among the restructured giants, so returning cash to stockholders appears a likely move should stocks continue to fall. The cash is likely to come from inflated prices and reduced capital expenditure.

Paper buyers will feel the pressure. Higher prices will take effect without relaxation on terms and contractual arrangements (i.e., volume). Since the paper companies will no longer tolerate money-losing accounts, supply cut-offs will be swifter.

Inventories have been very balanced all year. Executives have had one hand on the market pulse and the other on the paper machine brake. This is particularly true for unbleached kraft linerboard and recycled boards, which have seen steady decreases in inventories and little replenishment of take-out. Converters will need to plan deliveries better or suffer price punishment from rush orders or upward shifts in quality due to low stock. Fee capture is a high margin activity.

Avoiding the squeeze

There are several options to wiggle around these paper company power plays, which should not upset either entity in paper transactions. The first is the old-fashioned lecture about establishing longer term contracts. Buying "as needed" was fine when there were so many warehouses full of paper. But today's concentrated world of paper distribution may not offer the same freedoms. However, there are innovative ways to buy paper-using price pegs, hedging and just buying smart.

Price pegs are available, like pulp prices, secondary fiber prices, containerboard usage, PPI and other economic data, from government and industry associations. Monthly or quarterly adjustments are made and prices are paid based on a periodic lag (i.e., the last data recorded). It's a good way to keep the supplier honest and take advantage of economic changes.

Hedge your bet

Hedging is a fairly new concept. The Dow Jones Commodity Service and the London and Helsinki stock markets offer paper trading of futures and options contracts in pulp and other commodities like secondary fiber. GE Capital and Enron can provide trading services. Although these services have been around for some time, they have not so far attracted a high level of trading volume.

The Internet and B2B e-commerce provide another option. Though volumes so far are very, very low and growth is slower than expected, this might be a place to pick up bargains. Large producers already have strategies in place to service online buyers, and the real fight for market share is evident here. As volume develops, it might be tempting for paper companies to quietly offer idle machine time (i.e., tons) to anonymous online buyers.

Buying smart

Barter arrangements are used in "inter-company sales", but arranging waste hauling and pickup with a local paper company could produce mutual benefit. The so-called "mini-mills" were based on this simple idea. Helping your vendors with waste-paper supply among your customers might also produce positive results.

Buying smart is the hardest and requires the most work, but it pays off. Buying annually or off a volume through a firm, delivered price is the best way to buy paper. The time to buy paper is probably the late spring or early autumn, when things are quiet after the big back-to-school volume periods. The buyer can better plan the budget, and the seller has a base of production on which to work. It builds rapport and longer term commitment.

Ask your vendors to submit bids openly, and go through no more than two rounds. After the decision, there can always be adjustments, but you can use your energy and resources on your business, and leave the worrying about paper stocks to the Wall Street gang.

If you found this article helpful, CIRCLE 205 or Inquire Online.