Surge may be over for now
How Sappi changed its spots and its fortunes
With the share having shot up to around R100 recently, some investors could just have missed the boat
Around 30% of Sappi shares are held by the Public Investment Corp, the Government Employees Pension Fund and the Industrial Development Corp — and that is a fat vote of confidence in the group from government.
This is, after all, a company that has struggled to appeal to the broader market in the years since the global financial crisis began. This is probably because it took seven years to more than double from below R20 to about R40 between 2009 and 2015. Now, having shot up to around R100 more recently, it’s been deemed a great-value share.
Sappi delivered "robust" full-year results to September 2017 on "strong growth" from speciality packaging and its dissolving wood pulp business. Full-year profit of $338m rose from $319m in 2016.
The group has further reduced debt in the period, as it continues to reorientate operations away from the core business of fine-coated paper used in upmarket advertising and publishing materials.
The focus now is on high-margin dissolving wood pulp, also called chemical cellulose, used in making clothing and textiles — and on specialised packaging products.
But the turnaround has been long and slow, and only the most optimistic supporters have stuck around. The recent upward rush may also have reached a peak for now, says Electus Fund Managers analyst Mish-al Emeran, as the "low-hanging fruit" has been picked.
"[There is a] need to strike a balance between growth and the risk of oversupplied markets. We think the share price reflects the turnaround, [but] key catalysts have played out," he says.
Chemical cellulose is the key area of growth for Sappi, Emeran says. But there could be significant additional global supply in the medium term. In the past year there was strong demand for the product, Sappi says, growing at double digits.
This is why the group’s capital expenditure in 2018 is expected to increase to $450m as it continues to convert mills in SA, Europe and North America to produce greater amounts of its chemical cellulose and speciality packaging. The latter is a sector that has enormously benefited SA pulp, packaging and paper manufacturer Mondi, as the Internet cut into Sappi’s traditional fine-coated paper markets.
Mondi has built up world-class packaging production assets in emerging European markets, while Sappi has been hampered by more expensive output costs at its mills and factories in developed European countries. Mondi only really ever made office paper, so the Internet has not been as damaging to its paper business.
But with the move to chemical cellulose and also speciality packaging, Sappi is starting to reassert itself. Both Sappi and Mondi have significant facilities in SA, Europe and the US, which supply world markets. Meanwhile, with the rand remaining weak, SA is a good place for basic product inputs, including competitive forestry resources.
For Sappi, Europe is its biggest market at 41% of sales, followed by Asia at 26%, and the US 23%. SA accounts for 10% of the total. Coated paper is still Sappi’s biggest product segment, at 56% of all sales. Speciality paper makes up 11%, commodity paper 7% and chemical cellulose 20%. But with spending during 2018 focused on higher-margin growth segments, including chemical cellulose and speciality packaging, this will position Sappi for stronger profitability from 2019 onwards, says CEO Steve Binnie.
"We have been through a period of being very conservative," Binnie says. "We halved debt over the past four years from $2.5bn to $1.3bn.
"Our success in bringing our debt levels to below our targeted leverage ratio of less than two times net debt to [earnings before interest, tax, depreciation and amortisation] in [financial 2016] meant we could turn our attention to increased investments in growth projects."
Markets for chemical cellulose are predicted to grow at about 5%/year.
Sappi supplies about 20% of the global market — much of this to China, India and Indonesia. The product is also widely used in cigarette filters, cellophane, pharmaceuticals and in making foodstuffs.
But Binnie says demand for textiles has been so good that Sappi has not yet had the opportunity to enter these other markets.
Emeran says management has done well to turn the business around. He says balance-sheet strength and flexibility have been restored, amid good cost control across divisions. Investors will also be pleased that Sappi’s dividend in 2017 leapt 36% to US$0.15 year-on-year.
Wade Napier, diversified resources analyst at Avior Capital Markets, says Sappi "is very comfortable" in terms of its balance sheet. He says it has never fully repaid its debt because debt is a useful means of enhancing equity returns in a low global interest-rate environment.