Sappi pays to lose its gloss

Durban ? Sappi is due to release full-year financial results on Monday.

Interest will extend beyond the numbers. South Africa's largest paper and pulp producer might explain recent announcements on planned closures of mills.

There's no mystery why Sappi is closing them. Overcapacity has long been the biggest problem in the global industry, particularly in the key West European market, outstripping weakening demand and keeping a cap on price increases.

But Sappi's mill closures come at a high cost, following its acquisition of four mills from M-real for €750m (nearly R9bn then) in November. Sappi might be leading the way in reducing capacity, but why is it shouldering the cost on its own?

"If they could have, Sappi might have held out and let M-real go bust [the Finnish company had been running up losses for a few years]. But Sappi couldn't hold out - it was facing a crunch and had to move. It paid M-real to close capacity," said Mohamed Kharva, an investment analyst at Nedbank Capital.

Before Sappi's announcements in October on the pending closures of two more mills - one in Swaziland, the other in Finland - Kharva had a "sell" recommendation on the share. He maintains it, saying despite recent closures Sappi still has a long way to go to reduce capacity significantly.

But why is Sappi doing much of this on its own (though Mondi has also announced a mill closure)?

Could the leading players in the industry not have banded together and collectively shared the cost of buying capacity to shut it down?

"The other guys didn't need to move. They have an element of cross-subsidisation from other paper products and grades of paper. Sappi is very reliant on coated fine paper [glossy paper]; the long-term outlook is not good, under pressure from both the decline in advertising - and therefore demand for glossy paper - and the gradual move from paper to the electronic media."

The four mills Sappi bought from M-real were all coated graphic paper producers. Part of the acquisition price was funded through a controversial rights issue to raise €450m, pitched at a discount of more than 60% to Sappi's share price at the time, about 5 800 cents per share. Sappi is now trading at 2 810c/share. The rights issue also more than doubled Sappi's shares in issue.

Kharva believes Sappi's results next week might surprise on the upside. "I think there might be an improvement in North America," he said.

But Western Europe remained the problem. Sappi has a relatively higher cost base there than competitor Mondi with its mills in Eastern Europe, and a legacy dating back to earlier management of wanting to be biggest in its markets, often at the expense of profitability.

- Fin24.com