Sappi mill pulp operations. Picture: FINANCIAL MAIL
Sappi mill pulp operations. Picture: FINANCIAL MAIL

Weak demand in graphic paper product categories in Europe and North America prompted Sappi to significantly cut back on production in those regions in the second quarter to March.

The world’s largest maker of dissolving wood pulp intends reducing the profit contribution from its graphic paper business to about 25% from 40% to focus on high margin businesses “in the next few years”, CEO Steve Binnie said on Thursday.

The “much weaker” conditions in the sector validate Sappi’s strategy to refocus operations away from the dwindling graphic paper best known for use in glossy magazines to the higher-margin dissolving wood pulp, which is used in making clothing and textiles, and specialised packaging products.

Sappi reported relatively weak results which saw shares fall 8.53%, the largest one-day drop since August 13, 2018.

Binnie said as a result of the unfavourable market conditions the company took a production downtime of 85,000 tons across its paper machines in Europe and North America.

He said the ailing graphic paper markets, which took a knock from the economic slowdown in Europe, would contribute to lower full-year profits.

“Given the current weak market conditions for graphic paper, dissolving wood-pulp pricing pressure from oversupplied viscose stable-fibre markets and our more conservative outlook on the global economy, the second-half and full-year profitability are now expected to be below that of last year,” Binnie said.

Sappi said despite expected reduced capacity from competitors, either through closures or conversions of graphic-paper mills, it might take the remainder of the calendar year before sufficient capacity was removed “to allow operating rates and margins to recover”.

Mish-al Emeran, an equity analyst at Electus Fund Managers, said the faster than expected decline in the coated paper market was a concern. “It is true that some competitors are reducing capacity, but given the high operational leverage, if the market continues to decline at current rates we think Sappi would be hard-pressed to cut some capacity.”

Emeran said Sappi management had done well to reduce the firm’s debt, “but going forward there is more of an emphasis on growth”. He said the company’s growth strategy, which entailed increasing the proportion of dissolving wood pulp and specialities, implied increased operational risk, given the cyclical nature of the markets it operated in.  

“Striking a balance between capacity expansions into specialities and dissolving wood pulp versus the risk of oversupplied markets will be key – rapid capacity growth inevitably leads to over-capacity and poor pricing power. But with Sappi now trading in the low R60s, we do think that most of this risk is priced in,” he said.   

Second-quarter profit fell to $72m from $102m a year before, while net debt rose marginally to $1.7bn.

As part of its plans to target higher-margin segments, Binnie said Sappi’s capital expenditure for the rest of 2019 was expected to be about $370m.

njobenis@businesslive.co.za