by Reid
Carter
The author
is a paper and forest-products analyst at National Bank Financial in Vancouver,
British Columbia, Canada. This article was adapted from Carter’s
speech at NAA’s May Convention in Toronto.
Believe it or not, the newsprint sector has the most positive outlook among paper and forest-product commodities. But amid a storm of structural changes in the newspaper and papermaking industries, producers and publishers have grown hostile to each other. A careful examination of the market demonstrates the potential negative effect of this hostility on both industries.
Three indexes suggest that newsprint supplies and demand can achieve balance:
• Total U.S. consumption fell 12.9 percent from January through May, and dropped 11.7 percent in May alone. For the first five months of this year, total U.S. consumption was 8.2 percent below the 10-year average. In the United States, consumption by all dailies for the period from January to May was down 410,000 metric tons, or 10.2 percent, year over year. That’s 5.8 percent below the 10-year average.
• Total inventories, meanwhile, at 1.8 million metric tons, match the 10-year average. Yet mill inventories stand at 459,000 metric tons, 10.7 percent below the 10-year average of 514,000 metric tons. Inventories held by all U.S. newsprint users are 103,000 metric tons, or 7.8 percent, above the 1.4 million ton 10-year average. In 2001, total inventories have increased by 269,000 metric tons, or 17.1 percent, with consumer inventories accounting for 156,000 metric tons of the increase.
• Since 1987, North American newsprint-production capacity has increased by 900,000 metric tons, while domestic consumption has declined by 2.6 percent. Exports have soaked up the difference, increasing from 11.8 percent in 1987 to 18.9 percent in 2000. Clearly, export markets have become critical for maintaining the balance of North American supply and demand.
While leading North American producers are expected to export a larger share of their tonnage going forward as they attempt to keep North American newsprint production and consumption in balance, export shipments have dipped in recent months as producers focused on more lucrative domestic accounts. At the same time, imports remain low, just 225,000 metric tons in 2000. That represents a drop of 202,000 metric tons, or 47.3 percent, from 1999.
Whereas the strong North American economy in 2000 allowed producers to run at 97.6 percent of capacity, the economic slowdown in the first half of 2001 has created difficulties for both producers and publishers. The North American newsprint market currently exhibits a fine balancing act between mill and consumer inventories. While mill inventories remain low, consumer stocks push the upper limits. This may pose dangers for both producers and consumers.
THE
LONG TERM
Burgeoning inventories
reflect just one of the market forces at work as publishers and producers map
uncharted territory.
During the past five years, advertising revenue increased 5.6 percent per year while newsprint consumption increased by only 1.2 percent per year. Now, slowing newspaper advertising revenue and rising newsprint prices are negatively affecting publishers’ earnings.
Yet producers and publishers voice shock at the resulting decline in demand for newsprint. Traditionally, a slide in newspaper advertising causes the price of newsprint to soften. In studying North American consumption patterns, these trends appear predictable. Price mirrored consumption throughout 1980-2000.
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Beginning in late 2000, however, price and consumption started to follow diverging paths. While consumption fell by 13.5 percent through the first four months of 2001, prices remained relatively stable, above the trend at $625 per metric ton. Prices appear to have broken from their historic path.
This departure has not been without challenge. Efforts by producers to raise prices by $50 per metric ton March 1 met stiff resistance. After two months, producers moved prices back by $25 per metric ton in recognition of publishers’ revenue difficulties. Yet strained relations continued, with producers ultimately lowering prices another $25 per metric ton. Still, newsprint prices and a weak advertising climate cause publishers to focus on conservation measures such as cancellation of excess circulation and value-added sections. Consumption falls anew.
The situation might be viewed as one effect of consolidation among producers and publishers alike. Yet on the producer side, at least, one data run, in particular, shows a positive effect of consolidation among paper producers of all kinds. When you compare the peak-to-trough changes in prices during the 1990s with the average market share among the top-five paper producers for various pulp, paper and paperboard grades during the same period, the results show that price volatility generally declines with consolidation of the manufacturing sector (see bottom graph at left).
Mergers and buyouts among papermakers proliferate, with tissue manufacturers now having the greatest degree of consolidation. The top-five tissue manufacturers produce 84.0 percent of the North American market; the top-five bleached-board producers, 73.0 percent; and the top-five newsprint manufacturers, 73.3 percent. In contrast, market-pulp manufacturers show the least consolidation, with the top five manufacturing only 42 percent.
Consolidation of the North American newsprint industry may be approaching its limits. Many observers expect the most recent round of contraction to lessen price volatility.
Industry concentration, as measured by a scale known as the Herfindahl-Hirshwin Index, is approaching levels where further consolidation among the large newsprint manufacturers probably can’t proceed much without raising antitrust concern for regulators in the United States and Canada. However, there should still be considerable room for smaller producers to join together.
While the recent consolidation of newsprint producers does not necessarily create a monopoly, industry leaders still face antitrust concerns and will have to be increasingly careful as prices appear to be set by the actions of a handful of producers. This view prevails because the U.S. Justice Department’s antitrust investigations across all industries generally appear to be focused on price fixing more than on pseudo-monopolistic behaviors stemming from industrial consolidation.
THE
NEW REALITIES
Consolidation among
publishers obviously makes them more resistant to price swings, regardless.
The top-five newsprint consumers buy 35.0 percent of North American consumption
annually; the top-10 buy 51.9 percent. And those market shares may be understated
because smaller companies buy through groups such as the recently formed Newsprint
Buyers Consortium in Ketchum, Idaho.
This consolidation across the newsprint and publishing industries has resulted in a new set of business conditions. Buyers and sellers have grown so big that they must get along. They can no longer afford to cancel each others’ contracts. Both sides now have too much at stake over the long haul.
For example, consolidation has resulted in a shift in power, giving producers the scale to close capacity. Thus, newsprint facilities will be converted or closed at a rate that should more than offset the expected decline in demand.
For 1999-2002, in the United States and Canada, Abitibi-Consolidated and Alliance Forest Products, both of Montreal; Bowater Inc. of Greenville, S.C.; Great Northern Paper of Millinocket, Maine; Inland Empire Paper Co. of Port Angeles, Wash.; Irving Paper of St. John, New Brunswick; Madison Paper Industries of Kennebec, Maine; Manistique Paper of Manistique, Mich.; and Uniforet’s Tripap Paper mill in Trois Rivieres, Quebec, plan North American newsprint-capacity closures or conversions totaling 2.3 million metric tons of newsprint production a year. At least five plants will be permanently closed or converted to noncompeting grades. Other converted paper machines will continue to produce uncoated papers.
As a result of these conversions, North American production of groundwood specialties will increase 30 percent between 1998 and 2002. The 10-year demand for them has grown an average 7.0 percent a year. In fact, some value-added grades will displace newsprint—we just don’t know how much.
Consolidation and retrenchment also seem to be breaking the historic relationship between newsprint and pulp prices. In the middle-left graph on p. 36, newsprint prices have been set back four months and displayed with pulp prices to demonstrate that newsprint prices followed those of pulp until the late 1990s. During the last year, this relationship appears to have begun to break down, reflecting post-consolidation supply-side management.
CATCH
22
The dynamics of supply and
demand are upsetting the newsprint market at a time when publishers also are
challenging producers to meet clients’ grade needs. This requires capital
investment by producers.
New newsprint machines can bleach and calendar surfaces, thereby improving newsprint brightness and surface characteristics in ways publishers now require. Publishers also insist on stronger paper with better runnability to avoid costly lost production on their presses. Such demands will continue as both editors and advertisers use more color in more complex configurations.
Publishers don’t search for quality newsprint simply to improve return on capital. These demands form key components of their efforts to enhance circulation and readership and allow print media to compete.
As shown on the bottom-left graph on p. 36, the real price trend is negative, having declined in real dollars by 66 percent since 1980. Producers now operate in an environment where publishers and advertisers have come to expect declining real prices.
Rising costs for energy, freight and chemicals have increased costs by $25-to-$60 per metric ton in 2001, further squeezing producers’ margins.
Publishers often ask whether producers spend enough to meet their needs. Frankly, that is getting tough. Inadequate profitability and the need for capital investment suggest to Wall Street analysts that paper companies’ stock-market valuations will continue to be under pressure, further limiting their access to capital.
The return on capital investment for the “average” North American producer depends on its operating rate. The target should be at least 1-to-2 percent above these companies’ average cost of capital, or approximately 12 percent. Newsprint companies haven’t come close to meeting that goal for a long time.
Investors have withheld capital from pulp-and-paper producers as they’ve lost confidence in producers’ ability to create value and as momentum capital moved from industrial commodities to the technology, media and telecommunications sectors. This taught paper company leaders that they must make investments capable of yielding adequate returns.
Publishers have been more profitable than producers, with returns on capital investments averaging 11.8 percent vs. 7.9 percent for producers during the past six years.
This should not imply that increases in producer profitability should come at the expense of publishers. The focus needs to be on profitability and long-term viability for both industries. Producers have to assess the impact of conservation initiatives while keeping an eye on the economy. Readership and circulation become key, and all parties must understand that their competitors include radio, television and the Internet. Both sides must foster a more amicable approach to meeting each other’s needs.
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